How to save tax by investing in ELSS mutual funds

Traditional instruments of saving taxes generally include a long lock-in period and may not provide desired returns according to your financial objective.

However, investing in an ELSS fund (Equity Linked Savings Scheme) can be a smart way to grow wealth while also saving on taxes since these mutual funds are designed for tax-saving purposes with the benefit of a shorter lock-in period.

In this article, you will understand what ELSS funds are, their tax benefits, and why they are worth considering for your investment portfolio.

What is an ELSS Fund?

ELSS funds are a category of mutual funds that primarily invest in equities and equity-related instruments and generate growth through capital appreciation. They are unique in a way that they offer tax benefits under section 80C of the Income Tax Act, 1961, making them a preferred choice for investors looking to save on taxes while seeking potential capital appreciation over the tenure.

Tax benefits of investing in ELSS funds 

Investing in ELSS funds allows taxpayers to claim a deduction of up to ₹1.5 lakh under section 80C of the Income Tax Act. This means that the amount invested in ELSS funds is deducted from the taxable income, leading to lower tax liability.

Additionally, ELSS funds have a lock-in period of three years, which is the shortest among all tax-saving instruments under section 80C. It’s important to note that this tax deduction benefit under section 80C is only available to individuals following the old tax regime. 

How to invest in ELSS Funds?

You can invest in ELSS funds like any other mutual fund investment such as through online platforms, mutual fund distributors, or directly through the Asset Management Company (AMC). 

You can choose between lump-sum investments or Systematic Investment Plans (SIPs) based on your preferences and financial goals. It's essential to research different ELSS schemes and consider their past performance, fund manager expertise, and expense ratio before making an investment decision.

Things to consider when investing in an ELSS fund

Before investing in ELSS funds, there are a few factors to consider:

• Risk appetite: ELSS funds invest predominantly in equities, which carry higher risk compared to debt instruments. Investors should assess their risk tolerance before investing.
• Investment horizon: ELSS funds are best suited for long-term investment goals due to their equity-oriented nature. Investors should have a horizon of at least three to five years to ride out market fluctuations.
• Fund performance: Evaluate the past performance of ELSS funds, considering factors such as returns generated over different time periods and consistency in performance.
• Expense ratio: Look for ELSS funds with a lower expense ratio as it directly impacts the overall returns. A lower expense ratio implies higher returns for investors.
• Tax implications: While investing in ELSS funds offer tax benefits, it's essential to understand the tax implications upon redemption.

Conclusion

Investing in ELSS mutual funds presents an opportunity to save taxes while participating in the growth potential of the equity markets. With the dual benefit of tax savings and wealth creation, ELSS funds serve as an ideal option for investors seeking to build wealth over the long term.

However, it's crucial to make informed investment decisions by considering factors such as risk appetite, investment horizon, and expense ratio. By understanding these aspects and incorporating ELSS funds into your investment strategy, you can effectively plan for your financial future while optimising tax savings.