ELSS funds are a popular tax saving mutual fund scheme under section 80C of IT Act 1961. Many studies over time have proven that equity investments can generate a lot of value in the long run. But if you are looking to save tax under section 80C and capture the growth of equity markets, you may find your options limited.
ELSS mutual fund is one of the four options available to you as an equity investor who’s also looking to save tax. Other option being the Unit Linked Insurance Plans (ULIPs), pension plans from private life insurers and New or National Pension Scheme (NPS).
Check the investment ideas into ULIPs and NPS here How to Make ULIP Plans Work to Your Advantage and How to Make the Most Out of Your NPS Investments
Here are the important insights into the workings of this tax-saving mutual fund which every wise investor should know:
1. Pure Equity Mutual Fund
As per the guidelines from Ministry of Finance (see Reference #3) the ELSS mutual fund must invest at least 80% of its corpus in equity shares or related instruments. The mutual fund can keep the remaining 20% of the corpus to in short-term debt or liquid securities to meet the withdrawal requests from investors.
With 80% of asset under management (AUM) invested into equity shares, the ELSS funds earn most of their value from equity. Thus, they are pure equity funds, and best serve the aggressive long-term investors.
2. Safest of All Pure Equity Mutual Funds
ELSS funds are just one type of equity mutual funds available in the market. The following two features make them one of the safest equity funds:
- Large portion of AUM invested in large cap (or blue-chip) stocks
- Passively managed
Blue-chip stocks are the largest firms listed on the stock exchange, with proven track record of performance. These are the least volatile stocks, thus carry lower risk.
Passive management means the fund generally does not actively trade in stocks. Therefore, the fund value is not affected a lot by short-term variations in few stocks.
3. Lock-in Period but no Maturity
The Ministry of Finance has recommended a three-year lock-in period for the investors of ELSS funds. This is because this fund allows a tax-deduction under section 80C.
Meaning if you invested up to Rs. 1.5 Lakhs in this fund in a financial year, your taxable income will reduce by 1.5 lakhs. Lock-in ensures that investors don’t end up taking undue advantage of the scheme and re-invest the same money by withdrawing every year.
ELSS schemes have a three-year lock-in starting from the moment you receive the units in the fund. For example, if you buy units in ELSS on 3rd June 2020, your ELSS lock-in will end on 2nd June 2023. Thus, as an ELSS investor you should be ready to stick in for at least three years from the time of investment.
Lock-in does not, however, mean maturity period. You can stay invested in the ELSS fund beyond the three-year lock-in period.
4. 10-12 Years is the Sweet Period
The correct investment period for ELSS investors is 10 to 12 years. Unless you plan to use ELSS only as a tax-saving investment, you should aim to maximize your returns from the plan.
As per our estimates, ELSS plans beat other similar investments for a period of 10-12 years. So, if you are planning to include ELSS schemes in your investment portfolio, make sure to align it with a financial goal which is 10-15 years from now.
See more at “Why you should stay invested for at least 10 years in ELSS?”
5. When to Start Investing in ELSS Funds
This question has two angles to it – 1. At what age you should get into ELSS? And 2. At which point in the financial year?
Given the investment-risk in ELSS mutual funds, and 10-year investment period, the best time to invest in ELSS funds would be between 25 to 40 years of age.
It is understandable that if you would like to use SIP mode for your investment into ELSS. Best is to start early in the financial year. It gives you two benefits:
- You can maximize your tax-saving investment
- Save yourself from the burden of additional TDS levy on your salary in the JFM quarter of the financial year
Read more about whether you should opt for SIP in ELSS here.
6. When to Stop Investing in ELSS Schemes
Knowing when to stop your ELSS investments is as important as knowing when to start. If you look at the financial year angle of the question, you may stop at any of the following points:
- You have met your tax-saving target for the year
- Your ELSS investment target as per your financial goal plan is complete
As per the age factor, you should probably stop about 7-5 years before starting your retirement. Stopping at least 7 years before retirement gives you ample time to withdraw your ELSS funds properly and turn them into your retirement treasure.
7. How to Exit From ELSS Mutual Fund
Exiting from your long-term investment is an inevitable step. This is also one of the least attended steps for a majority of investors. However, a planned exit from high-risk and long-term investments can benefit you greatly.
Similarly, you should plan your exit from ELSS investments too. The best way to withdraw from ELSS funds would be to withdraw using systematic withdrawal or transfer plans Instead of withdrawing all of the money at the same time
Read more about “Systematic Withdrawal and Transfer Plans here” also see “Why you should avoid full withdrawal from Equity Investments?”
- Section 80C of Income Tax Act 1961: https://www.incometaxindia.gov.in/Pages/tools/deduction-under-section-80c.aspx
- ELSS Defined: https://www.sebi.gov.in/legal/circulars/oct-2017/categorization-and-rationalization-of-mutual-fund-schemes_36199.html
- ELSS Rules 2005: https://www.incometaxindia.gov.in/pages/rules/equity-linked-savings-scheme.aspx
- ULIP vs. Mutual Fund Investment Periods: https://www.standardwealthonline.com/ulip-vs-mutual-funds/