Investing in mutual funds is one of the best ways for diversifying your investment portfolio. A well-diversified investment portfolio can help you fetch better returns and mitigate risk to a great extent. However, are you saving your taxes while investing in mutual funds or other investment vehicles? You may say that there are very limited financial instruments that offer higher returns and tax-saving benefits at the same time, which is true to an extent as well. The solution is investing in elss funds. 

What are ELSS funds?

The term elss funds stand for Equity-linked Savings Scheme. It is an equity mutual fund that invests 80% or above of its asset under management into equity and equity-related instruments. This asset allocation has been set by the Ministry of Finance in 2005. 

ELSS funds offer tax deductions up to Rs. 150000 (as per the recent tab slab) under section 80C of the Income Tax Act, 1961. If you invest in ELSS funds, your money will be locked-in for 3 years. Though this seems to be a hurdle if you are planning for long-term investment which usually equity investors do, then three years lock-in period shouldn’t affect you. Moreover, amongst other tax-saving investment schemes, ELSS has the shortest lock-in period. 

Types of ELSS funds

ELSS funds are one of a kind because when it comes to ELSS funds you can choose between growth funds and Dividend payout options. 

• Growth Funds ELSS offers wealth accumulation over the long-term and at maturity,  you can have a huge corpus and also realize the full amount of the fund when you withdraw the fund at maturity.
• The Dividend Payout ELSS can again be categorized as Dividend Payment and Dividend reinvestment funds. As the names suggest, if you opt for Dividend Payment, then you will receive a tax-free dividend from these funds while if you chose to invest, your dividends earned from the fund will be reinvested in the scheme again. 

Why you should include ELSS funds in your investment portfolio?

Including ELSS funds can be a great step towards building a healthy investment portfolio that will offer you these things: 

• Saves taxes with ELSS. Among all types of mutual funds, only ELSS funds offer deductions on taxes. The amount you invest in ELSS every year can be used to get deductions from the taxpayer’s gross income with an upper limit of Rs. 1.5 lakhs. Suppose you invest Rs. 200000 in ELSS funds in a year, so, you can deduct Rs. 150000 from your gross income which helps you save taxes. Section 80C of the Income Tax Act allows this deduction for ELSS funds. The returns you generate from these funds will be taxed as per long-term capital gain taxes. However, only if the returns from the fund are over and above Rs. 1 lakh at redemption.
• Long-term investment options for wealth creation. As ELSS funds are equity funds, so, wealth creation is the main objective of these funds apart from tax savings. Thus, these funds offer higher returns and help in accumulating wealth over the long term. You can expect an average return on ELSS funds around 13.5% for 5 years bracket.  Compared to other tax savings instruments like PPF and NSC, ELSS provide higher returns, however, the returns are not guaranteed as it is an equity instrument that is market-linked.
• Shorter lock-in period. Usually, tax-saving investment instruments such as Public Provident Fund (PPF) and others have a lock-in period of at least 5 years whereas ELSS has only 3 years as a lock-in period. The lock-in period means the duration within which you cannot redeem the fund. So, if you are investing a lump-sum amount in ELSS, you cannot withdraw the same for the next three years. If you are investing via SIP, then each SIP amount will have a separate 3-year lock-in period. So, if you have short-term investment goals, like buying a car in the next 3–5 years, or having an international trip, then you can use ELSS investment can come in handy. 

Who should include ELSS funds in their portfolio?

ELSS funds can be a suitable investment instrument for many of you. For instance, 

• If you are in your 20s and just started your career
• If you want to invest in equities but are not sure about direct investment in them
• If you are looking to diversify your investment portfolio and save taxes at the same time
• For investing in ELSS funds, you do not need to look at your age. You can invest in this fund when you are young as well as if you are close to retirement. 

Final thoughts

Achieving higher returns and tax-saving benefits in one investment instrument is rare. However, With ELSS, you can achieve both. ELSS funds can benefit investors of any age group and help them inculcate good saving and investment habits too.

John Wayne did his degree in psychology at the University of Hertfordshire. He is interested in mental health, wellness, and lifestyle.