Should you invest in ELSS funds?

Nothing is certain but death and taxes. You cannot escape it. However, one can surely try to reduce tax liability by investing in avenues which are made available under Section 80 C of the Income Tax Act, 1961. Here, one of the options available is Equity-Linked Savings Scheme (ELSS).

ELSS is a type of equity mutual fund wherein the investments made up to ₹1.5 lakh is eligible for tax exemption. However, the caveat here is that it comes with a three-year lock-in. This ensures an investor stays invested despite the volatility in the market thereby helping in wealth creation. In effect, by investing in an ELSS, an investor gets a package of tax benefits and wealth creation at the same time.

Understanding ELSS funds

ELSS funds have had an over two-decade-long history. As the awareness around mutual funds gained traction, given the tax benefits attached, this category of funds became popular among the masses. However, Budget 2023 had an announcement that made a lot of people question if indeed investing in an ELSS fund is a good idea. This is because the Finance Minister made the deduction-and-exemption-free new tax regime the default tax filing mode from FY24 onwards. Given the newer tax regime offers higher tax rebates, should you shun ELSS?

The answer is certainly not. At its very core, an ELSS fund is a diversified equity mutual fund that offers you attractive returns in the long-term if one stays invested for three years or more. Another positive aspect is that investors have flexibility in terms of the quantum of investment. There is no cap limit, unlike some other traditional investment options. Also, you can invest in lumpsum or stagger investments through SIP.

So, tax deduction should never be the main purpose to invest in an ELSS fund, instead it should be wealth creation. The category average return of ELSS for a five, seven and 10-year SIP period is 12-13% which is very impressive.

For a person looking to invest in an ELSS fund today, there are two types of ELSS funds on offer. One is an actively managed ELSS fund and the other is a passively managed ELSS fund. Most ELSS funds available today fall in the category of actively managed funds. In such a fund, a fund manager actively picks stocks from across market capitalization to build a portfolio. On the other hand, in case of a passively managed fund, the portfolio will simply mirror an underlying index and the returns too will be akin to the index minus expenses. Right now there are only a couple of passive ELSS funds available.

If you are inclined towards investing in an actively managed ELSS fund, during the due diligence stage, do check the long-term track record of the fund, fund performance during various market cycles and the likes. This is to ensure that the strategy followed by the fund works irrespective of the market environment. The three-year lock-in period gives an edge to ELSS fund managers to outperform the benchmark because they don't have to worry about redemptions owing to the stock market moves.

Should you invest in ELSS funds now?

There is never a wrong time to invest in an equity mutual fund be it ELSS or others. While one can start a systematic investment plan (SIP) in ELSS funds anytime they want, a lump sum investment needs some element of planning, especially at times when the market valuation is not cheap.

To conclude, investing in ELSS provides tax-efficient diversification to the portfolio, while aiming to create wealth over the long-term. As a result, this is one investment avenue to build wealth while reducing one’s overall tax burden. Do remember it comes to redemption post lock-in, it is treated just like an equity mutual fund. A capital gain of up to ₹1 lakh in a financial year is exempt from taxation while the remaining amount is taxed at a flat rate of 10%.

Given all these aspects, ELSS funds are one of the best options to take exposure in equities. The lock-in period promotes a disciplined approach to investing. While you may give the tax benefit angle some priority, wealth creation should be the main agenda with this investment.

Disclaimer: This article is authored by RC Rawal, Director,Imperial International. The opinions expressed are those of the author and do not necessarily reflect the views of Business Insider India. Mutual Fund investments are subject to market risk. Read the scheme-related document carefully before investing. Do your own research (DYOR) before deciding to invest in any financial asset class.