Tax-Efficient Mutual Funds: Suitable Investors and Investment Guidelines

While mutual funds may be a great way to potentially grow your earnings, it could also help you save on taxes via an Equity Linked Savings Scheme (ELSS). By investing in these tax saving mutual funds, you can receive tax deductions of up to ₹1.5 Lakhs during an ongoing fiscal, under Section 80C of the Income Tax Act, 1961.

According to SEBI, these are classified as open-ended equity mutual funds that can invest a minimum of 80% of their overall assets in equity or related instruments. The main investment objective of an ELSS fund is to ensure long-term growth or capital appreciation. 

Learn more about who can invest in ELSS, its features, and much more in the following sections.

How does an ELSS fund function?

ELSS funds feature a maturity period of 3 years and offer comparatively higher returns, but they are also exposed to a greater degree of risk. This is because they are market-linked tools. Its total assets are typically allocated by the fund manager across various market capitalisation segments, such as small-cap, mid-cap, and large-cap. 
 
The interest returns earned by you at the end of the 3-year lock-in period will be treated as Long Term Capital Gain (LTCG). Here, they will be taxed at 10% if your returns cross ₹1 Lakh. 

Who Should Invest in ELSS Mutual Funds?

As tax-saving investment instruments, ELSS funds are ideal for most investors. However, here’s a list of individuals who are recommended to explore this avenue. 

⦁    First-time Investors
If you’re just starting out on your investment journey, consider investing in ELSS funds via SIPs. Over the due course of time, you will be able to earn favourable returns during market upticks. Moreover, the lock-in period will help inculcate a habit of investing and saving. The tax benefits provided on investing in ELSS funds is also an added advantage. 

⦁    Salaried Individuals
As a taxpayer, you can consider investing in ELSS funds to reduce your tax obligations and earn lucrative returns at the same time. Unlike certain tax-saving instruments, you can invest in a number of ELSS funds to diversify your portfolio. In addition, by aligning your short-term goals with the investment, you can utilise the funds accordingly once they’ve matured in 3 years. 

Things to Consider Before Investing in ELSS

Below are some of the things to keep in mind before choosing to invest in ELSS mutual funds: 

⦁    Returns
It is important to consider a fund’s performance with its competitors, and the best way to determine this is via benchmarks recorded in the past. While no particular fund can be expected to remain at the top at all times, the good ones tend to perform quite well for extended periods. It is recommended to go for those that have consistently outperformed for around 5 to 10 years. 

⦁    Financial Goals
Choosing the right type of fund can be interlinked with your own financial goals. If you plan on availing only tax-saving benefits, then you can pair ELSS funds with other investment tools. Even if you are looking to achieve long-term financial goals, then ELSS can be in alignment with them, due to its high returns. You can make use of the lump sum calculator to determine your returns accordingly. 

⦁    Expense Ratio
Funds having a lower expense ratio are the most suitable as this determines how much of the investment amount goes into fund management. This way, you will be able to earn much higher returns, making it a crucial factor to consider during the time of making investment decisions. 

⦁    Fund Manager
Choosing the right fund manager can have a significant impact on your funds and their returns. They need to be well-informed and careful about choosing the best stocks, with the aim of developing a strong investment portfolio for investors.  

Benefits of Investing in ELSS

⦁    Low Minimum Investment
You will only be required to invest a small sum of ₹500 as a SIP to get started with ELSS investments. 

⦁    Short lock-in period
ELSS funds feature one of the shortest lock-in periods out of most mutual funds, and can be aligned with short-term financial goals.  

⦁    Convenience in dealing
It is quite easy to begin investing in ELSS mutual funds as the process can take roughly a few minutes online. This can help save you the hassles of paperwork and other formalities.

⦁    SIP Option Available
You can easily invest in ELSS funds via SIPs, typically starting at a minimum amount of ₹500. Using an online SIP calculator for ELSS mutual funds, you can also estimate your total returns at the end of the maturity period. 

Investing in ELSS funds is a good idea if you’re looking to reduce your tax liability, while learning lucrative returns. Simply align your investments with short-term financial goals to enjoy maximum benefits.