ELSS Mutual Funds 

Looking to save taxes and grow your wealth at the same time? ELSS (Equity Linked Saving Scheme) a tax-saving mutual fund combines wealth creation with tax benefits. Learn how ELSS works, its benefits, tax implications, risks, and how to invest. 

What are ELSS Mutual Funds?

ELSS mutual funds stand for Equity Linked Saving Schemes. These funds are known for their tax-saving benefits. They invest at least 80 per cent of their assets in equity and equity-related instruments and the remaining in the debt market. By investing the majority of their portfolio in equity, the fund aims to earn high returns. 

ELSS also comes with a mandatory lock-in of 3 years. This means you cannot sell your ELSS mutual funds before 3 years from the invested date. When you invest in an ELSS mutual fund you can claim tax deduction under section 80C of the Income Tax Act. So for example, if you invest ₹50,000 in an ELSS fund, you can deduct the same from your taxable income. This helps reduce your taxable income in turn reducing your overall tax liability.

List of Best ELSS Funds to Invest Today

List of the top-performing equity-linked savings scheme mutual funds sorted by returns with their AUM and Expense Ratio.

How do ELSS Mutual Funds work?

As per Equity Linked Saving Scheme, 2005, ELSS funds should invest a minimum of 80% of total assets in equity and equity-related instruments. These funds are invested in large-cap, mid-cap, and small-cap stocks. As mentioned above, ELSS fund holders are liable for a tax deduction under section 80C.

When investors like you buy units of equity-linked savings schemes either through a lump sum or a SIP (Systematic Investment Plan), the investor must stay invested for at least 3 years. Depending on the fund, the fund managers deploy your investment in diversifying industries and market cap. 

Under section 80C, taxpayers can claim deductions under many schemes. ELSS is one of the schemes in this regard. Investors can claim a deduction of up to ₹1,50,000 from your taxable income. For example, if your taxable income before deduction under section 80C comes to ₹12,00,00 you can deduct ₹1,50,000 and bring it down to ₹10,50,000.

Why invest in ELSS? Key features of the Equity Linked Saving Scheme

Investing in ELSS mutual funds is a good option if you want to save tax and it helps taxpayers build long-term investing habits with potentially high returns. Key features of equity-linked savings scheme include:

1. Tax Benefits: The primary benefit for investors is tax savings. Investors can save up to ₹46,800 in taxes with this investment scheme.

2. Lock-in Period: ELSS funds come with a 3-year lock-in period, designed to instill long-term investing discipline among taxpayers

3. Potentially High Returns: ELSS funds invest majorly in equity stocks which means they have a potential for generating higher returns compared to other tax-saving schemes.

4. Compounding Benefit: Considering investors stay invested for 3 years, the scheme allows investors to benefit from compounding. Which results in wealth creation.

What makes ELSS better than traditional tax-saving instruments?

Apart from ELSS, some other tax-saving schemes include the NPS scheme, ULIP, PPF, Tax Saving FD, etc. The primary difference between these schemes and ELSS is that equity-linked savings schemes have the lowest lock-in period of 3 years.

A lower lock-in period also ensures more liquidity than other tax-saving investments. Moreover, since ELSS funds invest in equity they also have the potential to generate more returns than these funds.

Who should Invest in ELSS?

ELSS mutual funds are a good investment choice for:

• First-time investors:  If you're new to investing, ELSS can be a great starting point. With a lower investment barrier and a structured lock-in period, it helps build long-term investing discipline while offering exposure to equities.
• Salaried individuals: ELSS falls under Section 80 C, which makes it an ideal choice for salaried professionals looking to reduce their taxable income.
• Young Professionals: ELSS encourages early-stage investors to start investing with small amounts through SIPs, helping them develop a habit of disciplined investing.

How to choose the right ELSS fund?

To decide which ELSS fund you must pick you need to analyse its portfolio allocation and returns. This includes looking at the fund manager's expertise, benchmark performance, Sharpe ratio, alpha, beta and more. We’ve explained in detail how you can pick an equity mutual fund for yourself here. Understand and use these metrics to pick a fund for yourself.

Are ELSS Mutual Funds taxable?

Since equity-linked saving schemes have a lock-in period of 3 years, they are not subject to short-term capital gain (STCG). Any gains from selling these funds after 3 years are subject to long-term capital gain or LTCG at the rate of 12.5%. Let’s understand this with an example:

Say you invest ₹1,50,000 in an ELSS fund today. Since ELSS has a 3-year lock-in period, you cannot redeem or sell your units before this period ends. Assuming after 3 years the value of your investment grows to ₹2,10,000. Here’s how the taxation works:

Total capital gain = ₹2,10,000 - ₹1,50,000 = ₹60,000

So, the tax you need to pay is: 12.5% of ₹60,000 = ₹7,500.

Can I switch ELSS funds after investing?

Yes, you can switch ELSS funds, but here’s how it works: Let’s say you’ve invested in an ELSS fund but later find another fund that better suits your needs. Since ELSS comes with a 3-year lock-in, you have two ways to switch:

1. For Lump Sum Investors: If you’ve already invested ₹1,50,000 in a financial year, you can’t transfer this amount to another fund. However, you can pause new investments in this fund and start investing in a different ELSS fund from the next year. Switching will be possible only after the lock-in period of 3 years ends.
2. For SIP Investors: If you’re investing through SIP, you can stop the current SIP and redirect your future contributions to another ELSS fund. This allows you to continue claiming tax benefits while moving to a different fund.

In both cases, your existing investment remains locked for three years and can only be withdrawn after the lock-in period ends. You can’t directly transfer your investment from one ELSS fund to another, but you can redirect future contributions to a better-performing fund.

How to compare different ELSS funds?

When deciding which ELSS mutual fund to invest in, it’s important to analyse and compare key performance metrics. Here are some important factors to look at:

1. Benchmark Performance: Check if the fund is matching or beating its benchmark index. This helps you assess whether the fund is underperforming or outperforming over time.
2. Expense Ratio: A lower expense ratio is better, as high expenses eat into your returns. Compare expense ratios to ensure you’re not paying more than necessary.
3. Beta: This measures the fund’s volatility compared to its benchmark. A higher beta means the fund is more volatile, while a lower beta suggests it’s relatively stable.
4. Alpha: Alpha shows how much excess return the fund generates compared to its benchmark. A higher alpha indicates better fund management and performance.
5. CAGR (Compounded Annual Growth Rate): This tells you the average annual return of the fund over a period, giving you a clearer picture of its long-term performance.

By analysing these metrics, you can make a more informed decision and choose the right ELSS fund for your goals.

Should I invest in ELSS via SIP or lump sum?

Whether you should invest in ELSS via SIP or lump sum depends on your investment goals. Let’s consider each option and the benefits associated with it.

If you invest in ELSS via SIP:

You benefit from rupee-cost averaging. The best aspect of investing through a systematic investment plan (SIP) is you do not have to time the market. When the market is down you get more units for less rupee, similarly in a market rally you get fewer units. Overall averaging out your investments. Secondly, you build a consistent investment habit. Also, an ideal choice for salaried employees, since they can set out a certain amount every month and invest religiously for a longer haul.

If you invest in ELSS via lumpsum:

Investing in lumpsum is perfect when you have extra cash and want to invest all of it at once. Moreover, if the market is down, you buy more units at a lower price. Another great benefit of investing in a lump at the beginning of the financial year is that you can maximize tax benefits under Section 80C and keep your tax planning sorted for the year.

Can senior citizens invest in ELSS?

Yes, senior citizens can invest in ELSS. However, whether ELSS is the right choice for investors or not depends on their goals, risk appetite and investment horizon. Here’s how:

1. First, ELSS funds offer tax savings. If the senior citizen has taxable income and wants deductions under section 80C they can invest in ELSS to claim the benefits.

2. Secondly, Equity-linked saving schemes are linked to the market. This means while they offer the potential for high returns they also come with high risk. If the senior citizen is willing to take on risks and the core focus is on capital appreciation, not preservation, this fund might work.

3. Lastly, ELSS funds have a lock-in period of 3 years. If the investor is confident they can invest in a fund that does not allow pre-mature withdrawal and will not need funds for immediate needs, they can explore ELSS.

How much should I invest in ELSS?

There is no fixed amount on how much you should invest in ELSS. It depends on your investment needs. Under Section 80C of the Income Tax Act, taxpayers can claim a total deduction of up to ₹1,50,000 in a financial year.

If you have already invested in other tax-saving instruments, but the total doesn’t add up to ₹1,50,000, you can invest the remaining amount in ELSS to maximize your tax benefits.

Similarly, if ELSS is the only tax-saving investment you’re making, you can invest the full ₹1,50,000 to claim the deduction. And if capital appreciation is your goal beyond tax savings, you can even invest more than the tax deduction limit.

Is ELSS a risky investment?

ELSS funds invest in equities which means they are linked to the market and will be followed by volatility. These funds are high risk but are also followed by potentially higher returns than traditional tax-saving instruments like FD, PPF, etc. 

Is ELSS only for tax saving?

No, ELSS funds are not only for tax savings. Investors also find these funds a suitable choice for capital appreciation. ELSS funds allocate investments in mid-cap, large-cap, and small-cap stocks. These funds are known for their high-risk, high-return profile.

What kind of returns can I expect from ELSS?

Equity-linked saving schemes invest in equities, which means their returns are market-linked. ELSS funds have given  an average CAGR of 13.97% over 3 years, 17.96% over 5 years and 13.04% over the last 10 years

How to Invest in ELSS?

You can easily invest in ELSS mutual funds through INDmoney. To do so download the app and click ‘Mutual Funds’ from the bottom menu bar. Search for ELSS funds. From here select funds that suit your investment goal and invest either a lump sum or set up a SIP.

What happens if I stay invested in ELSS for more than three years?

You can continue to stay invested in an ELSS fund even after three years. If you decide to do so, you enjoy the benefits of an equity mutual fund like you would in any other open-ended scheme. Since these funds invest in equities, you stand the chance to benefit from compounding and long-term wealth creation.

What happens to my ELSS tax benefits if I redeem them after three years?

You enjoy tax benefits on ELSS only for the financial year in which you invest. So, for example, if you invest ₹1,50,000 in FY 2024-25, you can claim a tax deduction under Section 80C for that year. However, if you redeem your investment after 3 years, you do not get any further tax benefit. Additionally, if you make a gain on redemption, it will be subject to long-term capital gains (LTCG) tax.