5 Reasons to Invest in ELSS (Tax Saving Mutual Funds)

'A penny saved is a penny earned', so goes a famous saying.

Since taxes can eat into one's investment returns, tax saving should form an integral part of every individual's financial planning exercise. Taxpayers who have opted for the old tax regime have the option to select from various tax-saving instruments such as Public Provident Fund (PPF), National Saving Certificate (NSC), Tax Saver Bank FD, Equity-linked Saving Scheme, etc.

Out of the various instruments that offer a tax benefit, Equity-linked Saving Schemes (ELSS), also known as Tax Saving Mutual Fund, is one of the most worthy avenues for investors willing to take some risk.

What are ELSS (Tax Saving Mutual Funds)?

SEBI defines ELSS (Tax Saving Mutual Funds) as open-ended equity schemes that come with a statutory lock-in period and tax benefit. These funds invest a minimum of 80% of their assets in equity and equity-related instruments. ELSS have the flexibility to invest across sectors and the market cap spectrum. Furthermore, they also have the freedom to follow a growth, value, or blend style of investing. Recently, SEBI also allowed mutual funds to launch passively managed ELSS.

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Here is why investors may consider investing in ELSS (Tax Saving Mutual Funds):

1) Low lock-in period

ELSS (Tax Saving Mutual Funds) have a mandatory lock-in period of 3 years, which is the lowest among tax-saving instruments. This means investors can redeem their investment after the completion of 3 years from the date of purchase. National Savings Certificate (NSC) and Tax Saver FD both have a lock-in period of 5 years. On the other hand, Public Provident Fund (PPF) investments have a lock-in of 15 years, while the contribution towards National Pension System (NPS) are locked-in till the age of 60 years.

2) High return potential

ELSS (Tax Saving Mutual Funds) are equity-oriented mutual funds schemes which gives them the potential to reap higher returns for their investors compared to non-market linked tax-saving instruments. Tax Saving Mutual Funds invest in a diverse range of stocks spread across sectors and market caps, depending on the market conditions, to offer investors the benefit of diversification and capital appreciation. Thus, ELSS have the potential to deliver market-beating performance in the long run.

[Read: How to Select the Best ELSS for Tax-Saving]

3) Deduction under Section 80C

ELSS (Tax Saving Mutual Funds) are the only types of equity mutual funds that offer tax-saving benefits to their investors. Eligible investors can avail deduction of up to Rs 1.5 lakh under Section 80C of the Income Tax Act by investing in ELSS. It is important to note that though there is no restriction on the maximum amount that investors can invest in Tax Saving Mutual Funds or the number of schemes they can hold, the deduction under Section 80C is limited to Rs 1.5 lakh only.

4) Helps in ignoring market noise

When the market conditions turn uncertain and highly volatile, many investors rush to redeem their equity mutual fund investments. Being equity-oriented, ELSS (Tax Saving Mutual Funds) too are susceptible to the volatile nature of the equity market. However, since the investment is locked in for 3 years, it helps investors to ignore the market noise and stay invested for the long term.

Staying invested for the long term allows investors to mitigate the impact of market volatility on the portfolio. It also allows their wealth to grow with the power of compounding.

5) Flexibility to invest systematically

ELSS investors have the option to invest a certain fixed amount regularly via the Systematic Investment Plan (SIP). Investors can start investing in ELSS through the SIP route with a small investment amount of as low as Rs 500. The benefit of investing via the SIP route is that it helps mitigate the impact of volatility on the investment portfolio due to the integral rupee-cost averaging feature and, in turn, potentially compounds investors' wealth. In addition, it inculcates a disciplined approach to investing and saves investors from the worry of timing the market, which is necessary for earning optimal returns from the mutual fund portfolio.

That said, remember that in case of investment in Tax Saving Mutual Funds via the SIP route, each instalment is subject to a lock-in period of 3 years.

[Read: 3 Best ELSS to Invest in 2023 - Top Performing Tax Saving Mutual Funds in India]

Final thoughts...

Investing in ELSS (Tax Saving Mutual Funds) can maximise investors wealth through a diversified portfolio of stocks and also provide tax benefits. It is suitable for investors looking to earn inflation-beating returns and have an investment time horizon of at least 3 years, opting for the old tax regime.

As a category, ELSS (Tax Saving Mutual Fund) returns have been impressive over the long term. Numerous schemes in the category have generated significant alpha over the benchmark indices, which makes it a suitable avenue for planning long-term goals.

Being an equity-linked mutual fund, the securities in an ELSS portfolio can witness bouts of sharp volatility, and the investment value can see sharp fluctuations. However, ELSS has the potential to outperform most other tax-saving instruments in the long run.

Finally, when investing in ELSS (Tax Saving Mutual Funds), investors may prefer the Direct Plan over the Regular Plan. The lower expense ratio of a Direct Plan can help investors earn better returns over a period.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision.