How Does an ELSS Fund Work?

Most of us have two common goals- wealth creation and lowering our tax liabilities. While there are multiple financial instruments in the market, there is one instrument that can help you achieve both of these goals simultaneously. This instrument is called an Equity-linked Savings Scheme, or ELSS.

Let’s understand what an ELSS fund means and how it works.

An ELSS is a type of mutual fund that invests most of its investible corpus in equity and equity-linked instruments. ELSS funds are also known as tax-saving funds as they are the only mutual fund schemes that are eligible for income tax deductions under Section 80C of the Income Tax Act.

As discussed above, an ELSS mutual fund invests a majority of its principal corpus in equity-linked instruments like stocks. These stocks could be from various sectors and of different market capitalisations. Any remaining corpus that is not invested in equities is invested in other money-market or fixed-income instruments. Hence, investors of ELSS funds enjoy the benefit of capital appreciation when the market value of the invested stocks increases.

Here are some of the notable features of ELSS funds:

• Equity-linked investments

  An ELSS fund invests at least 80% of its principal amount in equity and equity-linked instruments.

• Capital requirement

  The minimum capital required to invest in ELSS funds is just ₹500.

• Lock-in period

  Any investment in ELSS mutual funds has a minimum lock-in period of 3 years. Compared to other tax-saving instruments, ELSS has the lowest lock-in periods. After the lock-in period, you can choose to either reinvest your total corpus or sell the securities and exit the ELSS scheme.

• Investment options: lump-sum and SIP

  You can choose to invest in an ELSS fund in a lump sum or through regular SIP instalments. If you choose to invest through SIP instalments, each instalment will have a 3-year lock-in period from the date of investment.

• Tax benefit

  ELSS funds are popular for their tax benefits. Investments in ELSS mutual funds of up to ₹1.5 lakh are exempted from tax and hence do not have to be added to your taxable income. Moreover, the returns from ELSS investments at the end of the lock-in period are taxed under the Long-Term Capital Gain (LTCG) provision, which means that the returns up to ₹1 lakh can be exempted from income tax and any exceeding amount will be taxed at 10%.

Some of the things to consider before investing in ELSS mutual funds are:

• Fund performance

  Before you choose an ELSS fund, you must compare the fund’s performance with its competitors and check if it has performed consistently in the past.

• Fund house

  Ensure that you choose a fund house that has shown consistent performance over a period of 5-10 years.

• Expense ratio

  The expense ratio of a fund tells you how much of your invested amount goes into managing the mutual fund. A lower expense ratio suggests would mean that you can have a higher takeaway return, so it is recommended to go for such funds.

• Fund manager

  Another important factor to consider before investing in any ELSS mutual fund is the fund manager. This is because the fund manager plays a key role in managing your funds and deciding where to invest the corpus. The ELSS fund manager must be experienced and competent in choosing the right stocks and creating a strong portfolio for the ELSS mutual fund.

If you choose to invest in an ELSS fund, ensure that you consider the above-mentioned factors and also understand the risks involved in each scheme.