ELSS funds: A beginner's guide to tax-saving mutual funds

You know that investing is important for securing your financial future. It helps you earn returns, grow your wealth, and achieve your long-term financial goals. But what if your investment could also help you reduce your tax liability? In today's world, where inflation and cost of living is increasing rapidly, investing in tax saving investment options has become more important than ever. That's where ELSS funds can help.

ELSS (Equity Linked Saving Scheme) funds are tax saving mutual funds that invest a major portion of their assets in equity and equity-related instruments. With ELSS schemes, you not only save taxes under Section 80C of the Income Tax Act (old income tax regime) but also get to earn market-linked returns. 

Key features of ELSS funds

ELSS funds invest in stocks across market capitalisations 

ELSS funds are diversified equity mutual funds that invest across different market capitalizations (large caps, mid caps, small caps). They also invest in companies across various sectors, including healthcare, banking, IT, and pharma, among others. With such diversification, ELSS funds offer investors added stability as their risk is spread out in the portfolio. 

You can choose from growth and dividend options

ELSS mutual funds offer growth and dividend options. Under the growth option, the returns are reinvested, and you can benefit from the power of compounding. Under the dividend option, the returns are paid out to the investors from time to time. 

Note that dividend pay-outs are subject to tax as per your taxable income. Therefore, it is advisable to opt for the growth option if your investment horizon is more than 5 years.

Short lock-in period

ELSS funds come with a 3-year lock-in period, which is the shortest when compared to other tax-saving investment options like the Public Provident Fund (PPF) and National Savings Certificate (NSC). The lock-in period provides fund managers enough time to execute their strategies to maximise your mutual fund returns

Once the lock-in period is over, you can withdraw or re-allocate investments as per your financial goals without any exit load restriction.

Minimum investment amount and no upper limit

ELSS funds give you the flexibility to begin investing with small amounts via Systematic Investment Plans (SIP). This allows you to manage your finances better and ensures that you don't have to strain your budget. And with no upper limit, you can channel more capital into the scheme if you are looking to seek higher returns.  

Understanding the taxation of ELSS funds

Since ELSS funds have a 3-year lock-in period, the gains are classified as long-term capital gains (LTCG) and taxed at 10% without indexation benefit. Note that the long-term capital gains up to Rs 1 lakh are tax-free.

However, holding ELSS funds for a minimum of five years is highly recommended. The longer you hold your ELSS units, the better chances you have of reaping the benefits of compounding, which can help you create wealth over time. Also, ELSS funds tend to perform well in the long term because of their equity-oriented nature, offering higher growth potential compared to other tax-saving instruments.

So, how can you invest in ELSS funds?

Investing in ELSS funds is extremely easy with the availability of numerous digital platforms and investment apps. Simply create an account, complete the KYC formalities, and choose the mutual funds to invest in. Most digital platforms also give the option to set up automatic investments through SIPs, which further simplifies the investment process. After investing, you can easily track your ELSS funds online, with regular updates and statements available on the investment portal or app.

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