Everybody likes to bring down their tax liabilities. And everybody wants their corpus to grow. So, if there is an investment instrument that provides both these perks, it is bound to climb the popularity charts.
Equity linked Saving Schemes or ELSS is the name given to these instruments. These tax-saving mutual funds can help in bringing down the income tax liabilities by Rs 1.5 Lakhs (as per the Section 80C provision)
While there are numerous tax saving options available in the market, ELSS has the potential for solid returns along with the shortest lock-in timeframe.
Salient features of the Best ELSS Mutual Funds:
- These funds invest a large portion of the portfolio in equities.
- They have a mandatory three-year lock-in period.
- These funds offer the twin benefits of tax savings along with wealth appreciation in the long-term (through equity investments).
- Flexibility to invest via the SIP (Systematic Investment Option) mode.
- Investors have the choice to go with dividend option if they want to get regular income. Alternatively, they can opt for growth option to benefit from long-term capital appreciation.
- Unlike other Mutual Funds, they do not levy any exit load.
Why should you invest in ELSS mutual funds?
- Tax Benefit
The factor that attracts most investors to the best ELSS mutual funds is the qualification for tax deduction (up to Rs 1.5 Lakhs in a financial year). Additionally, the returns from ELSS are exempt from tax (till the value of Rs 1 lakh). For income in excess of Rs. 1 Lakh, tax is levied at 10% (Long-Term Capital Gains).
- Step into the equity ecosystem
ELSS Funds are a great way to get initiated into the world of equity investments. As they have a compulsory three-year lock-in period, it gives investors (especially beginners) sufficient time to get used to the fluctuations and volatility witnessed in the stock market.
- Shortest lock-in time frame
If we look at other investment options that qualify for tax deduction under Section 80C, ELSS has the shortest lock-in period of three years.
For instance, PPF (Public Provident Fund) has a 15-year lock-in period while NSC (National Saving Certificates) have a five-year lock-in period. Even from the perspective of returns, ELSS has the potential to generate better returns as compared to these investment avenues.
Points to keep in mind while investing in ELSS Mutual Funds
- Risk Appetite
Many investors get attracted towards ELSS Funds as they have the potential to generate good returns. However, one should not forget that ELSS Mutual Funds invest primarily in stocks and equities. Even the best ELSS mutual funds require a good amount of risk appetite and as a result, they tend to be prone to market fluctuations and volatility, especially in the short run. Hence, before investing in ELSS one should ensure that they are ready to bear the risks associated with these funds.
- Lock-in Period
ELSS Funds have only a three-year lock-in period, which is one of the shortest amongst all other tax saving alternatives. However, one should not rush to exit from these schemes at the completion of the mandatory holding period. One should remember that equity investments bear the sweetest fruits in the long run. It is a wise decision to remain invested for at least five to seven years to optimize the returns.
How much should you invest in ELSS mutual funds
Now comes the most important question. How much investment is good enough? And how much is too much?
The answer to this question lies in a combination of factors:
- If the purpose of investment is solely tax savings
Many individuals choose to invest in ELSS Funds with the objective of saving taxes. Any appreciation in capital is just an added benefit for them. If you fall in this category, then you should remember that Section 80C of the Income Tax Act allows deduction only up to Rs 1.5 Lakhs. So, any additional investment (in excess of Rs. 1.5 Lakhs in ELSS) is not going to be helpful.
One should also take into account other contributions such as towards life insurance policies, provident fund (employee, voluntary and public), pension plans, saving certificates, etc. These also fall under the ambit of Sec 80C. If you are already making contributions towards any of these, then invest only the balance amount in ELSS.
- If one is looking for capital appreciation
Investors who choose ELSS for the primary objective of capital appreciation (or dual benefits of tax savings), are not restrained by the 1.5 Lakh limit. However, they need to keep these things in mind while increasing their investment in ELSS:
- Size of the portfolio
In case of large portfolio (for instance Rs 30 Lakhs annual incremental investment), 1.5 Lakhs contribution towards ELSS amounts to only 5%. One can go for an increased ELSS investment as well. However, one should take into account that in other mutual fund schemes, one is able to make a more well-informed decision on whether one wants large-cap, small cap or even multi-cap.
In case of a smaller portfolio (for instance Rs. 5 Lakhs annual incremental investment), 1.5 lakhs in ELSS amounts to 30% of the yearly investments. So, if 60-40 is the desired equity debt ratio, then an additional Rs 1.5 Lakhs can be parked in equity-based funds.
If the portfolio size is even smaller (for instance Rs 2 Lakhs annual contribution), then 1.5 lakhs in ELSS already amounts to 75% funds in equity. This is a highly skewed portfolio and may not be ideal even for risk aggressive investors.
Equity investments are just like sugary food items. We must bring down them down as we climb up the age ladder. So, if you are young, have just started your career or have no other financial liabilities, you can go for a higher contribution towards equity-based funds (including ELSS).
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Final Words: Do not forget the importance of Goal-Based investing
Last but not the least, ELSS (or any other investment option) should be taken up after analyzing one’s financial goals, their time horizon and risk quotient. If these three aspects are in sync with the features of ELSS, then go ahead with it.
Also, if one wants to optimize their returns from ELSS, they should start investing it in from the beginning of the financial year. Do not let it be a residual choice which is exercised in the last month of the year.