The fact that over 5 million Indians use SIP to invest in mutual funds on a monthly basis demonstrates that the ease, flexibility, and benefits of mutual funds are widely recognised and enjoyed in India. This is especially true among the younger working population, who may not have the time or willingness to regularly watch their investments. 

While there are age-old discussions about whether to invest in stocks or mutual funds, we'll see how the advantages of investing in a mutual fund are numerous. Mutual funds can assist in establishing a medium-long term corpus by providing diversified asset classes, flexibility and convenience of investment, the power of compounded returns, liquidity, professional portfolio mix management, and so on.

Aside from gaining exposure to various asset classes such as stock, debt, and commodities, there is a sort of mutual fund that can help you save tax year after year. Let's take a closer look at these. 

How Can You Gain Tax Breaks by Investing in Mutual Funds?

The Equity Linked Savings Scheme (ELSS) is a tax saver mutual fund that combines all of the benefits of participating in a mutual fund with the added benefit of tax savings each year. Here's a quick rundown of their most notable characteristics:

  • SEBI mandates that ELSS mutual funds invest at least 80% of their assets in equity shares and/or equity-related products.
  • As a result, these funds have a rather high-risk exposure because market volatility affects them rapidly and dramatically.
  • On the other hand, larger market upswings and bull runs can result in significant gains than other investment strategies.
  • The minimum lock-in period for ELSS mutual funds is three years, which means you cannot withdraw your money until the stipulated term has passed. However, there is no upper time limit; you can stay involved for as long as you like.

Tax saving mutual funds

What are the advantages of investing in ELSS mutual funds?

Here is a quick rundown of the benefits of investing in ELSS mutual funds.

1) Tax Advantages

To begin, Section 80C of the Income Tax Act of India specifies that all contributions made to ELSS are tax deductible up to 1.5 L every fiscal year. This can be 1.5 L in a single ELSS fund or spread over several fund schemes. 

2) A Brief Lock-In Period

Consider some of the other popular tax-saving options, as well as the lock-in periods for each.

  • Fixed Deposit (FD): 5 years, 
  • Public Provident Fund (PPF): 15 years
  • National Pension System (NPS): until 60 years old
  • National Savings Certificate (NSC): 5 years

ELSS mutual funds clearly lock in your money for a relatively shorter time period while providing the same tax benefit of Rs. 1.5 L per year as the other instruments.

3) Greater Potential for Profits

Another factor to consider is the potential return on investment. While market performance can never be completely predicted, ELSS investment has generated returns at par with other tax-saving alternatives due to its equity market exposure, occasionally outperforming them as well.

4) Comfort and Adaptability

As ELSS is a type of mutual fund, you can invest in it through an SIP for as little as Rs. 500 every month. This also helps you maintain consistency with your investment. You might also choose to invest in one lump sum. Furthermore, it can be completely administered online, eliminating the need to fill out paper paperwork or wait in long lines.

5) Diversification

Investing in ELSS has the unintended consequence of assisting in portfolio diversification. Having a diverse portfolio of shares and stocks reduces your risk and reliance on the performance of a single company.

Important Considerations Before Investing

Mutual funds provide other benefits aside from tax savings, but it's easy to see why tax-saving funds are so popular. ELSS mutual funds are ideal for new investors and anybody looking to save taxes while building wealth for the future. However, in the interest of "buyer beware," let us also discuss the main aspects to consider before investing your money in these schemes.

1) Risk and Investment Horizon

Due to their significant and direct exposure to the equity market, most ELSS mutual funds have a high-risk factor. Furthermore, as previously stated, they have a three-year lock-in period. So, before you invest, be sure that your risk tolerance enables it and that having your money locked up for three years is financially feasible for you. 

2) Previous Performance

It is frequently stated that past performance is no guarantee of future returns. However, knowing the past return trends might help you compare the success of your fund to the performance of other funds in the market. To identify the well-performing funds, look at their 1-year, 3-year, and 5-year returns. 

3) Experience of the Fund Manager

Each ELSS fund has a fund manager who is in charge of maximising returns while keeping risks to a manageable level. They supervise a group of analysts and researchers who monitor market movements and rebalance the portfolio in preparation for future developments. As a result, the work of a fund manager is critical since they handle your investment on your behalf. Furthermore, because you cannot withdraw your money before the end of the three-year period, researching the fund manager and their track record becomes even more important.

4) Expense Ratio

This is how the fund manager and the team engaged are compensated. This is distributed among all fund scheme investors and subtracted when units are redeemed. So, if the expense ratio is 1% and your total fund returns are 20%, your net return will be 19%. The smaller the expense ratio, the higher the returns. 

5) Taxes

In terms of taxation, we've covered the majority of the advantages of mutual funds in India. However, you should be aware of how the returns are taxed. These gains are classified as either short-term or long-term and are taxed accordingly. The Short-Term Capital Gains Tax does not apply to ELSS because it only applies when units are redeemed within one year of acquisition. As a result, ELSS returns (over Rs. 1 L per annum) are taxed at 10% under Long Term Capital Gains Tax.

Finishing Up

ELSS mutual funds offer a unique and beneficial combination of wealth creation and tax savings. Many salaried persons prefer the ELSS route to consolidate their tax savings because of a tax deduction of Rs. 1.5 L each year. However, tax savings should not be your sole goal when investing in ELSS; you should also consider risk and other variables.

Disclaimer: Mutual Funds are subject to market risks. Please read all scheme-related documents carefully before investing. 

Mutual Funds