If you’re exploring tax-saving investment options, Equity Linked Savings Scheme (ELSS) funds might be on your radar. This article provides a comprehensive overview of ELSS Funds, covering their definition, key features, taxation rules, and a comparison with PPF to help you make an informed decision.

What is the full form of ELSS?

ELSS stands for Equity Linked Savings Scheme.
It is a type of mutual fund that primarily invests in equities and offers tax benefits under Section 80C of the Income Tax Act, 1961.

Why is it Called Equity Linked Savings Scheme?

ELSS gets its name because:

• Equity-Linked – A minimum of 65% of its portfolio is invested in equity markets, meaning returns are market-driven.
• Savings Scheme – It qualifies as a tax-saving investment, allowing investors to deduct up to ₹1.5 lakh from their taxable income annually under Section 80C. This will be elaborated further down in the article.

What are ELSS Funds? ‘

ELSS funds are equity mutual funds with a diversified portfolio, primarily investing in publicly traded company stocks across large-cap, mid-cap, and small-cap segments. These funds aim to maximize long-term capital appreciation by selecting stocks based on detailed market research to create a risk-adjusted portfolio.

While there is no upper limit on investment, the maximum tax savings possible through ELSS investments is ₹46,800 per year, depending on the investor’s income tax bracket.

How Do ELSS Funds Differ from Other Equity Mutual Funds?

While ELSS funds and regular equity mutual funds both invest in stocks, there are key differences that set them apart:

1. Tax Benefits – ELSS investments qualify for tax deductions under Section 80C (up to ₹1.5 lakh per year), whereas most other equity mutual funds do not offer tax-saving benefits.
2. Lock-in Period – ELSS funds have a mandatory 3-year lock-in period, meaning investors cannot redeem their investment before this period ends. Other equity mutual funds typically have no lock-in, except for close-ended funds.
3. Investment Objective – Both ELSS and other equity mutual funds aim for capital appreciation, but ELSS funds specifically focus on tax savings along with wealth creation.

What is the typical return on investment for ELSS funds?

The returns from ELSS funds are market-linked, meaning they fluctuate based on stock market performance. However, historical data suggests that well-performing ELSS funds have delivered average returns of 10% to 12% per year over the long term.

What factors affect ELSS returns?

1. Market Performance – Since ELSS primarily invests in equities, returns depend on how the stock market performs over time.
2. Investment Duration – Staying invested beyond the 3-year lock-in period can help maximize gains and reduce the impact of short-term volatility.
3. Fund Selection – Different ELSS funds have varying returns based on fund management strategy, sector allocation, and stock select

Is PPF better than ELSS? (PPF vs ELSS)

PPF and ELSS serve different purposes, making the choice dependent on an investor’s financial goals and risk tolerance.

PPF offers fixed returns of around 8%, making it a low-risk, government-backed option. However, over a long period like 15 years, the real value of wealth may erode due to inflation.
ELSS, on the other hand, has a 3-year lock-in and provides market-linked returns.

Even the worst-performing ELSS fund has delivered 12.6% returns, while the best-performing ELSS fund has given 19.4% returns.

Does ELSS give better returns?

To compare, if you invest ₹12,500 per month for 15 years:

In PPF at 8%, your wealth grows to ₹42.42 lakh.
In a lower-performing ELSS fund at 12.6%, it grows to ₹1.02 crore.
In a top-performing ELSS fund at 19.4%, it reaches ₹1.12 crore.

PPF provides stability and guaranteed returns, while ELSS offers higher return potential with market risks. The choice depends on whether an investor prioritizes safety over growth or is willing to take risks for higher wealth creation.

How are ELSS funds taxed?

Capital gains from ELSS funds are taxed similarly to other equity investments in income tax calculations.

• Short-Term Capital Gains (STCG): If ELSS units are redeemed before 1 year (not applicable due to the 3-year lock-in period), STCG is taxed at 15%.
• Long-Term Capital Gains (LTCG): Since ELSS has a mandatory 3-year lock-in, all gains qualify as long-term capital gains.

Is ELSS taxable after 3 years?

After the three-year lock-in period, ELSS investments are subject to long-term capital gains (LTCG) tax.
LTCG up to ₹1.25 lakh per year is exempt from tax.
Gains exceeding ₹1.25 lakh are taxed at 12.5% without indexation benefits.

Previously, LTCG beyond ₹1 lakh was taxed at 10%, which led to confusion about a flat “10% tax” on ELSS. However, with the updated tax rules, the exemption limit has increased to ₹1.25 lakh, and the tax rate is now 12.5% on gains exceeding this threshold.

Who should invest in ELSS funds?

1. Salaried employees:

If you’re a salaried employee, you likely contribute to the Employees’ Provident Fund (EPF), a fixed-income investment. However, if you’re looking for higher returns while saving on taxes, ELSS can be a smart choice.

ELSS offers tax deductions under Section 80C along with market-linked returns.

Compared to other tax-saving investments like ULIPs (5-year lock-in) and NPS (locked until age 60), ELSS has the shortest lock-in period of just 3 years.
With full equity exposure, ELSS has a higher potential for long-term growth than fixed-income alternatives.

2. First-Time Investors Exploring Equity Markets:

If you’re new to investing, ELSS funds provide an easy entry into mutual funds while offering tax benefits.
Equity investments can be volatile in the short term, but over a 5-year period or more, the risk is significantly lower.
Investing through SIPs (Systematic Investment Plans) helps reduce market timing risks and average out investment costs.
SIPs in ELSS accumulate more units when markets are low, leading to better returns when markets recover.
For salaried professionals and first-time investors, ELSS offers an ideal mix of tax savings, equity growth, and long-term wealth creation.

3. If You Are in the Old Tax Regime:

As stated above, ELSS investments qualify for tax deductions up to ₹1.5 lakh per year under Section 80C. This can lead to maximum tax savings of ₹46,800 per year, depending on your tax slab. ELSS combines tax benefits and wealth creation, unlike other 80C options like PPF or FDs, which are low-risk but provide lower returns. It is one of the few 80C investments with an equity advantage, helping investors combat inflation over the long term.

Growth vs. Dividend vs. Dividend Reinvestment Options in ELSS

When investing in ELSS funds, you can choose between the Growth, Dividend, or Dividend Reinvestment options, each with its own impact on returns and taxation.

1. Growth Option

In this option, investors do not receive dividends.
Gains are realized only at the time of redemption, leading to compounded NAV appreciation over time.
This option is suitable for those looking for long-term wealth accumulation.
However, returns are market-linked and subject to capital gains tax upon redemption.

2. Dividend Option

Under this option, investors receive payouts in the form of dividends at periodic intervals.
Dividends are taxable as per the investor’s income tax slab.
If dividend earnings exceed ₹5,000, TDS of 10% is deducted at the source.
This option is preferred by those seeking regular income rather than long-term growth.

3. Dividend Reinvestment Option

In this case, dividends are reinvested into the fund to purchase additional units, boosting NAV growth.
Works best during bullish markets, as reinvested dividends benefit from rising stock prices.
Like the dividend option, tax is applicable on reinvested dividends as per the investor’s tax slab.
Each option serves different investment needs—growth for long-term compounding, dividend for periodic income, and reinvestment for NAV appreciation.

How to invest in ELSS funds?

Investors can choose from two primary methods to invest in ELSS funds, based on their financial goals and risk appetite.

1. Lump Sum Investment

A one-time investment where the entire amount is invested at once.
Suitable for investors with a higher risk tolerance and those looking to maximize returns in a rising market.
However, market fluctuations can impact returns if invested at the wrong time.

2. Systematic Investment Plan (SIP)

Allows investors to invest smaller amounts regularly (monthly or quarterly).
Helps reduce market timing risk by averaging out the cost of investment over time.
Ideal for first-time investors and those who prefer disciplined investing.

Should you do Lumpsum or SIP in ELSS?

The right choice depends on your financial situation, risk appetite, and market conditions.

Lump Sum Investment

Best suited for investors who have a large amount ready for investment and can tolerate market fluctuations.
Works well when markets are at a low point, allowing for potential higher gains in the long run.
The entire investment is locked for 3 years and can be withdrawn in full once the lock-in period ends.
However, if markets decline after investment, there is a higher risk of short-term losses.

SIP (Systematic Investment Plan)

Ideal for those who prefer disciplined investing and cost averaging over time.
Each SIP installment has a separate 3-year lock-in period, meaning withdrawals will be staggered.
Helps reduce market timing risks, as investments are made at different price points.
A good option for first-time investors or those looking for consistent and gradual wealth accumulation.

Which Option is Right for You?

If you have a lump sum amount available and can handle market fluctuations, a one-time investment may offer higher returns in a rising market. However, if you want to minimize risk and invest steadily over time, SIPs provide a structured approach with cost averaging benefits.
The choice between lump sum and SIP ultimately depends on your investment horizon, financial goals, and comfort with market volatility.

Is ELSS For You?

Under the new tax regime, Section 80C deductions are not applicable.
So if your primary goal is tax savings, there are better options like low-risk fixed-income instruments or alternative investments with more flexibility.
However, if long-term wealth creation is your focus, ELSS remains a strong option due to its potential for higher inflation-beating returns.

Conclusion

ELSS funds not only help you save taxes but also build long-term wealth with equity exposure. With the flexibility of SIP and lump sum investment options, they cater to different investor needs. If you’re looking for higher returns than traditional tax-saving instruments and can handle market fluctuations, ELSS is a compelling choice. Start early, stay invested beyond the lock-in period, and choose a well-performing fund to maximize your financial growth.

Kapil Jain is the Director of Enrichwise Financial Services Pvt. Ltd and Enrichwise Insurance Broking Services Pvt. Ltd., an IIM Indore Gold Medalist in Finance and an investor for 25+ years.
Enrichwise is an AMFI registered Mutual Fund Distributor and ISO 9001:2015 Certified.
For Investments, Insurance and Tax Advisory – Contact +919821860804 or email planner@enrichwise.com