If you are looking to invest in mutual funds that offer the dual benefit of tax deductions and wealth accumulation over time, Equity Linked Saving Schemes or ELSS are the right option. These mutual fund schemes come with a lock-in period of three years (that is shorter than other tax-saving investment options). They differ from liquid mutual funds that invest in fixed income securities like commercial paper, government securities, and treasury bills with a maturity of up to 91 days.
Let’s look at what you need to know about ELSS funds and how to invest in them.
What are ELSS funds?
Equity-Linked Saving Schemes or ELSS Funds in India refer to mutual funds that mainly invest in equities.
Their main features are:
- They are open-ended funds which means that you can buy or sell the units of these funds at any time
- These mutual funds allocate 65% of their funds towards investment in equity and equity-linked securities with the remaining being invested in fixed income securities or debt.
- They are tax-saving instruments as specified by Section 80C of the Income Tax Act. Tax benefits are available only on investments of up to 1.5 lakh rupees.
- The returns generated from these schemes are taxable under the dividend distribution tax and taxes on long-term capital gains.
- They come with a lock-in period of three years which means you cannot sell your units for the first three years.
- There is no upper limit for investing in these schemes with the minimum amount varying from one mutual fund to another.
- They are available with two options of growth and dividend. You can choose the one that matches your financial goals.
Growth vs Dividend Option
The growth option in the ELSS funds in India is suitable for you if you are looking for long-term wealth creation. In this option, profits earned on the investments are reinvested with the accumulated amount being paid in the end. The NAV of such schemes rises to reflects the profits made and falls in-line with the losses on investments made.
In the dividend option, you get dividend payments during the investment period. This means the profits made by the scheme are not reinvested and instead paid as dividends. Thus the NAV of the scheme gets reduced by the amount of dividend paid.
You need to choose between the two options based on your financial goals. If you look for long-term growth you can opt for the growth option. However, if you are looking for some steady returns, go for the dividend option.
Investing via SIP or Lump sum
You can invest in equity funds or ELSS schemes via two routes- the SIP route or a lump sum amount. When you opt for a SIP, you agree to contribute a pre-decided amount at fixed intervals to the fund. Each SIP is treated as a separate investment and so the standard three-year lock-in period applies to each instalment individually. You will, however, benefit from the rupee cost averaging effect which means the fund can buy more units when prices are down and less when prices are up.