Tax planning is an activity where most of us fail. A lot of us rush to explore a variety of tax-saving investment options towards the end of a financial year. There are plenty of investment options for saving tax under section 80C of the Income Tax Act, 1961. ELSS Funds or Tax Saving Mutual Funds are one such ideal investment option. With the shortest lock-in period of 3 years, it offers a maximum tax deduction of Rs. 1.5 Lakhs in a financial year.
In This Article
- What are ELSS Mutual Funds?
- Who should invest in Tax Saving Mutual Funds?
- Why should you invest in ELSS Mutual Funds?
- Benefits of Tax Saving Mutual Funds
- How to Evaluate the Best ELSS Funds
- Top 10 ELSS Funds to invest in 2021
- Things to consider before investing in ELSS funds
- Taxability of ELSS Mutual Funds
- Conclusion
What are ELSS Mutual Funds?
Equity Linked Savings Scheme or ELSS Mutual Funds are also known as tax saving Mutual funds. As the name suggests, they are one of the best investment options for you to save tax. They provide you with the duel benefit of saving tax as well as capital appreciation.
As per Section 80C of the Income Tax Act, you can now save up to Rs.1.5 Lakhs per year by investing in ELSS Mutual Funds.
These funds majorly invest in equity and equity-oriented securities. A part of the corpus is also in debt instruments. They have a lock-in period of a minimum of 3 years. It is the shortest as compared to the other option under section 80C.
Who should invest in Tax Saving Mutual Funds?
Anyone can invest in ELSS Funds, there is no barrier or restrictions for the investments. However, they are suitable for the investors who:
- Have the ability to take higher risks.
- Can invest for the longer term, i.e. minimum 5 years.
- Have advanced knowledge about these funds.
They are best suited for young investors who are in the initial years of their careers. Generally, young investors have enough time to fully utilize the power to compounding. They can enjoy high returns through investing in ELSS Mutual Funds.
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Why should you invest in ELSS Mutual Funds?
These are some of the best products than any other tax-saving investments under Section 80C. Other options are PPF, ULIP, NSC, and bank FDs.
1. Higher returns:Â Although, they invest majorly in equities. But, they have the potential to generate high returns. Though equities asset class can be highly volatile in short term. But they have the potential to generate a high return for the longer-term.
2. Shortest lock-in period: These funds have a lock-in period of just 3 years. It is the lowest among all other tax-saving investment options under Section 80C. Among the other options, NSC, tax-saving FDs, and ULIPs have a lock-in period of 5 years. Whereas PPF has a lock-in period of 15 years. Thus, ELSS mutual funds are highly liquid form among all other tax-saving investment options.
ELSS mutual funds offer a great potential to generate long-term wealth. These can be an excellent investment option for long-term financial goals. You can invest in these funds for goals like children’s education or your retirement.
Benefits of Tax Saving Mutual Funds
1. Dual benefit of Tax rebate and Wealth generation: ELSS Funds provides a benefit of saving tax under Section 80C of Income Tax Act, 1961. Although they have high exposure to equities. But they also generate higher returns resulting in long-term wealth.
2. Shortest lock-in period: As compared to the other tax-saving investment option under Section 80C, ELSS funds have the shortest lock-in period of just 3 years. Therefore, these funds are more liquid as compared to other investment options under Section 80C.
3. Potential to beat inflation: These funds stand out as they have the potential to beat inflation. Since they have high equity exposure, it leads to higher returns that can beat inflation.
4. Expert money management: Unlike all other mutual funds, ELSS funds also give you the benefit of expert money management by professional fund managers. These are backed by a team of professional analysts and market researchers. They choose the best performing securities to invest in.
How to Evaluate the Best ELSS Funds
1. Fund Returns: Always compare the fund’s performance with similar funds within the category. And make sure the fund has been consistent over the past years. However, always remember that past performance does not guarantee future returns. Future returns completely depend upon the market situation.
2. Fund History and Manager: Always choose fund houses that have consistently given good returns over a long period. A fund’s performance is based on the quality of stocks in the portfolio. Therefore, you must ensure to invest with a fund that is managed by a good fund manager with experience of giving consistent returns.
3. Expense Ratio: It shows how much amount of your investment is used for managing the fund. A low expense means a high take-home return and vice-versa. Therefore, if you find two funds that are similar, for example, they have some track record and similar asset allocation, you should go for the one that has a lower expense ratio.
4. Financial Ratios: To analyze the performance of a fund you must consider the financial ratios. They are parameters such as Sharpe ratio, Standard Deviation, Alpha, and Beta. A higher standard deviation and beta depict that the fund is riskier. Therefore, you should choose a fund with a low standard ratio and beta. A higher Sharpe ratio means that the fund offers higher returns for the additional risk you take. The fund manager plays an important role here.
Click here for a complete guide of Financial Ratios!
Top 10 ELSS Funds to invest in 2021
| Fund Name | Returns (%) | |||
| 1 year | 3 year | 5year | 7 year | |
| Axis Long Term Equity | 54.51 | 14.70 | 15.62 | 18.01 |
| Mirae Asset Tax Saver | 86.63 | 18.86 | 22.76 | — |
| Invesco India Tax Plan | 61.07 | 12.16 | 14.75 | 16.69 |
| Aditya Birla Sun Life Tax Relief 96 | 53.71 | 7.98 | 12.94 | 16.03 |
| DSP Tax Saver | 75.12 | 13.15 | 15.67 | 17.32 |
| Kotak Tax Saver | 71.08 | 14.72 | 16.54 | 18.07 |
| ICICI Prudential Long Term Equity | 76.07 | 12.22 | 14.26 | 15.77 |
| Motilal Oswal Long Term Equity | 63.97 | 8.89 | 17.28 | — |
| Tata India Tax Savings | 67.12 | 12.52 | 15.97 | 18.15 |
| Nippon India Tax Saver | 71.68 | 2.64 | 8.62 | 13.09 |
(Data as on March 26, 2021)
(Source: Value Research)
1. Axis Long Term Equity Fund
This fund invests 99.43% of the total investment in Indian stocks. Out of which 67.91% investment is in large-cap stocks. 18.06% investment is in mid-cap stocks. 3.04% investment in small-cap stocks.
- Assets: ₹ 27,216 Cr
- Expense Ratio: 1.61%
- Minimum Investment: ₹500
- Risk Grade: Low
- Return Grade: Above Average
2. Mirae Asset Tax Saver Fund
This fund invests 99.32% of the total investment in Indian stocks. Out of which 55.45% investment is in large-cap stocks. 16.78% investment is in mid-cap stocks. 9.59% investment in small-cap stocks.
- Assets: ₹ 6,351 Cr
- Expense Ratio: 2.00%
- Minimum Investment: 500
- Risk Grade: Below Average
- Return Grade: High
3. Invesco India Tax Plan Fund
This fund invests 98.86% of the total investment in Indian stocks. Out of which 52.2% investment is in large-cap stocks. 13.83% investment is in mid-cap stocks. 13.38% investment in small-cap stocks.
- Assets: ₹ 1,461 Cr
- Expense Ratio: 2.18%
- Minimum Investment: 500
- Risk Grade: Below Average
- Return Grade: Above Average
4. Aditya Birla Sun Life Tax Relief 96 Fund
This fund invests 99.81% of the total investment in Indian stocks. Out of which 39.75% investment is in large-cap stocks. 41.24% investment is in mid-cap stocks. 9.51% investment in small-cap stocks.
- Assets: ₹ 13,427 Cr
- Expense Ratio: 1.73%
- Minimum Investment: 500
- Risk Grade: Below Average
- Return Grade: Average
5. DSP Tax Saver Fund
This fund invests 98.65% of the total investment in Indian stocks. Out of which 59.91% investment is in large-cap stocks. 19.18% investment is in mid-cap stocks. 11.19% investment in small-cap stocks.
- Assets: ₹ 7,883 Cr
- Expense Ratio: 1.83%
- Minimum Investment: 500
- Risk Grade: Average
- Return Grade: Above Average
6. Kotak Tax Saver Fund
This fund invests 98.57% of the total investment in Indian stocks. Out of which 53.28% investment is in large-cap stocks. 26.63% investment is in mid-cap stocks. 11.29% investment in small-cap stocks.
- Assets: ₹ 1,679 Cr
- Expense Ratio: 2.25%
- Minimum Investment: 500
- Risk Grade: Average
- Return Grade: Above Average
7. ICICI Prudential Long Term Equity Fund
This fund invests 98.48% of the total investment in Indian stocks. Out of which 69.35% investment is in large-cap stocks. 5.52% investment is in mid-cap stocks. 14.96% investment in small-cap stocks.
- Assets: ₹ 8,251 Cr
- Expense Ratio: 1.82%
- Minimum Investment: 500
- Risk Grade: Below Average
- Return Grade: Average
8. Motilal Oswal Long Term Equity Fund
This fund invests 98.15% of the total investment in Indian stocks. Out of which 42.58% investment is in large-cap stocks. 26.88% investment is in mid-cap stocks. 12.39% investment in small-cap stocks.
- Assets: ₹ 2,024 Cr
- Expense Ratio: 2.02%
- Minimum Investment: 500
- Risk Grade: Average
- Return Grade: Average
9. Tata India Tax Savings Fund
This fund invests 99.55% of the total investment in Indian stocks. Out of which 71.03% investment is in large-cap stocks. 9.16% investment is in mid-cap stocks. 9.63% investment in small-cap stocks.
- Assets: ₹ 2,636 Cr
- Expense Ratio: 2.03%
- Minimum Investment: 500
- Risk Grade: Above Average
- Return Grade: Above Average
10. Nippon India Tax Saver Fund
This fund invests 98.2% of the total investment in Indian stocks. Out of which 64.97% investment is in large-cap stocks. 11.57% investment is in mid-cap stocks. 10.36% investment in small-cap stocks.
- Assets: ₹ 11,222 Cr
- Expense Ratio: 1.75%
- Minimum Investment: 500
- Risk Grade: High
- Return Grade: Low
Things to consider before investing in ELSS funds
You must consider the following factors before investing in ELSS mutual funds:
1. Lock-in period: ELSS funds have a lock-in period of 3 years and it is mandatory. You cannot make a premature withdrawal. Therefore, you should only invest in these funds if you are willing to stay invested for at least 3 years.
2. Risk factor: Since ELSS funds are equity-oriented, they are highly influenced by market volatility. These funds carry a high risk, unlike any other equity fund. Therefore, you must be willing to take the risk to invest in these funds.
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3. SIP and Lump-sum: Unlike all other mutual funds, ESS Funds also give you the option to invest in 2 ways: SIP or Lump-sum. Most investors prefer to go with SIP since it helps to stagger the investment in the long run. It also gives the benefit of rupee cost averaging in long run. Therefore, for ELSS funds, investing through SIP is advisable. A lump-sum investment is only advisable when there are high chances of overwhelming returns.
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Taxability of ELSS Mutual Funds
ELSS mutual funds are taxed unlike any other equity fund as they come under a class of equity schemes. Any dividend it offers is added to your income and it is then taxed based upon the income tax slab you fall under.
Dividends were tax-free in the hands of investors as the dividend distribution tax was paid by the fund house until budget 2021.
You can enjoy short-term capital gains as there is a mandatory lock-in period of 3 years. Here you cannot sell the fund units before 3 years, therefore the tax on short-term gains is non-existing.
For the long-term capital gains, amounts up to Rs. 1 lakh are tax exempted. Any amount exceeding Rs. 1 lakh is taxed at the rate of 10%.
Let’s understand it better with an example:
Suppose an investor invests Rs. 1.5 lakhs in an ELSS Fund.
Assuming that the investor sells the fund after 3 years at Rs. 3 lakhs, the capital gain is Rs 1.5 lakh.
Now the investor has to pay the tax on the capital gain exceeding Rs. 1 lakhs. Therefore, the taxable income is Rs. 50,000.
10% tax calculated on Rs. 50,000 is Rs. 5,000.
Thus, investors will pay a tax amount of Rs. 5000.
Click here to know more about how mutual funds are taxed!
Conclusion
ELSS Funds are one of the best tax-saving instruments. However, you should always access your risk profile before investing in these funds are riskier as compared to other tax-saving instruments.
They are known for overwhelming returns if you invest in a disciplined way through SIP. Choosing a fund plays a crucial role here. You should do significant research before choosing the right fund to invest in.
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