What is Equity Linked Saving Scheme (ELSS)?

As we saw earlier, there are various financial instruments that are eligible for deductions under section 80C of the Income Tax Act, 1961. Among all of them, Equity Linked Savings Scheme (ELSS) funds are by far the most popular among the investors looking to get high returns from equity apart from tax savings. As of March 2022, the total current investments (AUM) of ELSS funds were ₹ 1,51,594 crores.

Please note AUM related data for each category of mutual funds are freely available on the website of AMFI. You can visit https://www.amfiindia.com/ for more such information. 

So what is an Equity Linked Savings Scheme anyway?

ELSS is a special category of equity mutual  funds  which  offer  the  dual benefits of tax saving and capital gains to the investors. They carry a lock-in period of 3 years, which is mandated under section 80C. Once you invest in an ELSS, you will not be able to withdraw the amount  before  the  expiry  of  3 years.

Now you must be thinking that the lock-in period of 3 years is too long and your money will get blocked till then. This is, in fact, a good thing for the following reasons:

Firstly, in a regular open-ended equity mutual fund, the fund manager always needs to keep some part of the corpus idle to pay the investors who redeem the mutual fund on a daily basis. Since redemption can happen on any day, generally anywhere between 5 to 10% of the total corpus of the fund is kept idle. This means that this portion of the corpus does not earn any returns and   is similar to a non-productive asset for the investors.

The lock-in period of 3 years in an ELSS means that the fund manager is not obligated to meet any redemption requests, at least in the first 3 years of the existence of the fund. He can, therefore, invest a larger proportion of the fund, thereby earning higher returns for the investors

Secondly, ELSS promotes long-term saving habits. Since the investment is subject to a compulsory lock-in, even if you have the urge of redeeming the investment when it  starts yielding short-term gains, you cannot take the money out for at least 3  years. Thus purchasing the units of an ELSS scheme is a great way to invest for the long term. It can certainly give you good capital gains when the markets do well.

Some of the important features of an ELSS are:

• An ELSS is a type of mutual fund.
• It is an equity mutual fund, so most of its corpus is invested in shares. All ELSS funds carry a compulsory lock-in period of 3 years. You can
  not withdraw your investment before the expiry of this period.
• You can get a tax benefit of up to ₹150,000 by investing in an ELSS. Though the tax benefits are kept at the levels already mentioned, there
  is no limit to how much you can invest in ELSS.
• You can get a tax benefit of up to ₹150,000 by investing in an ELSS. Though the tax benefits are kept at the levels already mentioned, there
  is no limit to how much you can invest in ELSS.
• ELSS is a long-term investment. So, you can gain a high rate of return provided the markets do well in this period.
• There are both dividend and growth options available. You can choose the option that suits you the most at the time of investment.
• In India, any investment in an equity fund made for more than 1 year is considered to be a long-term investment, which is not subjected to tax. Hence, the amount that you will receive when you redeem the investment after 3 years will be tax-free in your hands.

One point that you have to always keep in mind is that just like in the case of equity shares, ELSS funds are also subject to market volatility. When the markets do well, ELSS will give you good returns since the prices of the stocks in which it has invested will increase, and vice-versa.