Investing in equities is known to have the most potential for growth. The over 75% growth of the Nifty, an index that tracks the best stocks in the Indian stock market, in the last five years underlines this fact. But, just like any other form of investment, equities also attract taxes. For investments below one year, your profit will be taxed at 15% and, in the long term, 10%. But equity-linked saving scheme (ELSS) is an option you could consider if you wish to save some tax. But how does it work? Is it any different from other mutual funds? Let us take a look.
What is ELSS?
Equity mutual funds allow you to appreciate your capital more than any other mutual funds options. An equity-linked savings scheme is such an equity mutual fund scheme, but it is eligible for tax deductions under the provisions of Section 80C of the Income Tax Act, 1961. Under the scheme, you can claim a tax reduction of up to Rs.1.5 lakhs for your contribution towards ELSS.
ELSS has a lock-in period of three years. That means the profit from the fund will be taxed as long-term capital gains at a flat 10%, further increasing the tax savings.
ELSS is an aggressive investment option. Up to 65% of the fund portfolio is dedicated to equities, and equities are known for their higher growth potential. At the same time, there is a higher risk involved with investing in them too. They also provide much-needed diversification as the rest of the portfolio may contain several other security types including debts, commodities, bonds, etc.
One drawback many point out is the lock-in period. But the same is only three years, which is the shortest among all section 80C investment options.
Features of ELSS
- The most sought-after feature of ELSS is tax benefits. It offers a tax rebate of up to Rs.1.5 lakh, and the profits are taxed at a flat 10% as they are long-term capital gains.
- ELSS funds have a lock-in period of three years. But understand that there is no provision for you to exit your investment before the lock-in period. This affects the liquidity of the fund considerably.
- ELSS allows you to invest according to your needs without many caps. The minimum caps are often three-digit numbers that differ for different pension funds, and there is no maximum cap. ELSS allows you to invest every month through SIP as well.
- Since ELSS primarily invests in equities, it is known to have a higher return potential. ELSS is considered the only tax-saving investment option that has the potential return to beat inflation.
Things to keep in mind before investing in ELSS
Returns of the fund: Different ELSS funds may perform differently. Hence, ensure that you compare the current performance of the fund with its past performance and also with its peeks to make sure you are choosing right.
Fund house: The fund house has a key role to play in how the portfolio is designed and how the fund makes decisions. Hence, ensure you do your research about the fund house as well.
Expense ratio: The expense ratio is charged by the fund house to meet the expenses of the fund. This includes compensating the fund manager. A higher expense ratio may eat into your earnings. Hence, ensure you choose a fund with a lower expense ratio.
ELSS is a beneficial option to invest in for the longer term. But ensure you invest according to your risk appetite and investment goals to get the best out of ELSS.