An Equity Linked Savings Scheme, or ELSS, is an equity mutual fund scheme that primarily invests in equity and equity-linked instruments along with tax benefits under Section 80C of the Income Tax Act, 1961. In this article, we will look at the pros and cons of investing in ELSS schemes.
An ELSS fund is structurally like any other mutual fund where the fund manager pools money from investors with similar risk tolerances and investment goals. It is an equity fund that invests at least 80% of the fund’s assets in equity and equity-related instruments across varying risk levels. ELSS funds are different from other mutual funds since they offer tax benefits under Section 80C and have a mandatory lock-in period of three years.
Equity-Linked Savings Schemes are the only equity funds that offer tax benefits. Investment in ELSS fund qualifies for tax deduction under Section 80C of the Income Tax Act, 1961. As per this Section, an investment of up to Rs.1.5 lakh in an ELSS scheme can be deducted from your taxable income every financial year. However, it is important to note that the tax benefits offered under Section 80C are applicable to all investments including ELSS funds.
ELSS funds invest in the stock markets. Hence, if the fund manager chooses stock in sync with the market cycle, then these funds can offer good return potential.
While the government has offered a list of investments under Section 80C for availing tax benefits, few of them have a lock-in period. A tax-saving fixed deposit has a lock-in period of five years, PPF has a lock-in of 15years, NSC has a lock-in period of five years, etc. Compared to all the options under Section 80C, ELSS funds have the lowest lock-in period of three years.
ELSS funds invest primarily in equity and equity-related instruments. Hence, there are market risks associated with ELSS funds. Unlike other tax-saving instruments, such as fixed deposits or PPF, there are no guaranteed returns when investing in ELSS. However, the high risk-return ratio combined with the lock-in period helps even out the market fluctuations and works in favour of long-term investors.
Since ELSS funds have a mandatory lock-in period of three years, you cannot withdraw your investments even if there is an emergency. However, this can also help instil financial discipline and long-term investment behaviour.