Tax saving mutual funds provide dual advantage of returns and tax benefit
By investing in a tax saving mutual fund, investors can not only grow their wealth but also reduce their taxable income, making it a popular choice among individuals looking to optimize their tax planning strategies. Of all tax-saving investments, equity linked savings schemes, or ELSS, help an investor reduce taxable income by the amount invested, lowering tax liability. ELSS, in essence, provides an efficient way to not only save taxes but also create wealth over time. It is, as the scheme’s name implies, a savings plan that is linked to equity.
ELSS is a type of mutual fund that, like any other diversified equity mutual fund, invests in equities. ELSS differs from traditional mutual funds in that it provides a tax benefit on the amount invested and thus has a three-year lock-in period for funds invested. Under Section 80 C of the Income Tax Act of 1961, the maximum amount that can be invested in ELSS for tax purposes in a year is ₹1.5 lakh.
How to select the right ELSS
Performance: Funds that have consistently outperformed and outperformed benchmarks over a longer time horizon should be preferred over those that have shown stellar returns only recently.
Diversification: Examine the schemes’ portfolios to ensure that the ones you’ve chosen have a diverse allocation to different sectors and stocks. This will provide scheme and portfolio diversification.
Market capitalisation: It is critical to determine whether the scheme is a mid-cap or a large-cap one. If you have a moderate risk appetite, you should invest in a large-cap tax-saving fund; otherwise, if you are willing to take a higher risk, you should invest in a mid-cap tax-saving fund. Some mutual funds take a more balanced approach. Remember that the sector-related portfolio allocation may change over time.
Investment plan: Connect your ELSS investments to a long-term goal, such as your children’s education, marriage, home purchase, or your own retirement needs. After investing in ELSS and receiving a tax benefit in the year of investment, the period following its lock-in becomes equally important. ELSS investments are typically made for a three-year period. They cannot be withdrawn before the mandatory three-year period has passed. However, this does not imply that they should be viewed solely as a three-year instrument.
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Over longer time periods, stocks outperform other assets. One can even consider holding them for a longer period of time because mutual funds perform better over time. If there is no need for funds, investments in ELSS funds do not need to be withdrawn after the mandatory three-year period and can be continued for a longer period of up to five years or more.
Here’s something ELSS investors should keep an eye on. ELSS funds are primarily equity-oriented and do not have the option of going into debt. A bear market can erode a significant portion of the gains made during a bull market. As a result, holding the investment in depressed market conditions would be preferable to redeeming after the mandatory period. Markets are near all-time highs, but forecasting the future may be futile. The markets have largely rewarded long-term investors. Rather than trying to time the market, the key is to spend enough time in it. One can begin a SIP in ELSS funds, but keep in mind that each SIP installment has a three-year lock-in period from the date of investment. When investing in equity funds, you can go lump sum or SIP, but your time horizon will be longer.
Conclusion: ELSS has the distinction of being the only tax saver with the shortest lock-in period, with the majority of these schemes having 100 percent equity exposure. Choose the growth option, in which the gains are not distributed as dividends but remain in the scheme to participate in the equity over time. ELSS can be a good kicker in your mutual fund portfolio over time if properly chosen and managed.
Author: Sanjeev Puri
Published: Investors India Magazine, December 2023 Edition
