Mutual Funds
5 Golden Rules of Mutual Fund Investing for First-Timers
Invest in ELSS (Equity Linked Saving Scheme) mutual funds for tax benefits and growth.
Tax-Saver Funds or Equity-Linked Savings Schemes (ELSS), are a category of mutual funds that offer tax benefits to investors. Here are it’s key features:
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Tax savings mutual funds work the same way as diversified multi-cap equity funds do in almost all respects other than the three-year lock-in period. ELSS funds help you invest in equity stocks across operational sectors and market capitalisations. A tax-saving mutual fund must maintain a minimum equity holding of 65%. The remaining 35% can be invested in assets that include fixed-income instruments such as bonds or money market instruments.
As of now, available ELSS schemes are managed by a fund manager or a team of analysts that choose, purchase and sell stocks with an aim to outperform the decided benchmark. If the scheme’s investment yields profits, the NAV (net asset value) of the scheme rises and the investors can sell their fund units at an increased NAV to gain profits from the investment.
The taxation rules for ELSS funds are the same as that of equity mutual funds. However, since there is a mandatory three-year lock-in period, investors can’t benefit from short-term gains. The tax saving mutual funds are tax-free up to Rs 1 Lakh in a single financial year. The gains that exceed this mark are taxable at 10% with zero indexation benefit.
ELSS funds are equity-oriented schemes that are sensitive to the market. Because of this, there is a high risk of short-term volatility. That said, these funds can offer returns that are notably higher than inflation in the long term, as per past data.
However, investors must bear in mind that the cumulative tax benefit they can get in a financial year is limited to Rs 1.5 Lakh as per section 80C of the Income Tax Act, 1961. In other words, while you can exceed the limit of Rs 1.5 Lakh when making ELSS investments, you won’t get any tax benefits if you invest in excess of Rs 1.5 Lakh in tax savings funds in a single financial year.
And so, it's best to invest in tax-saving funds only if you are looking to reduce your tax obligations, have a high-risk appetite and are seeking a long-term investment option. Further, its best if you consider Systematic Investment Plans (SIPs) to invest in these to avoid worrying about timing the market during ELSS investments.
Different fund managers use different investment strategies to deliver maximum returns. So, it’s crucial to understand a fund manager’s strategy before investing in an ELSS mutual fund. For example, analyze whether a fund manager is investing in large-cap stocks, small-cap stocks, or mid-cap stocks to understand if their strategy aligns with your investment goals and risk appetite.
Your objective behind investing in an ELSS fund should not only be saving taxes but also to fetch high returns on your investments. That is why you should always analyze the past performance of a fund before investing in it. Compare the fund’s performance with its peers to ensure that it has delivered consistent returns over the years.
The expense ratio of a mutual fund determines what portion of your investment goes towards the management of funds by the fund manager. A higher expense ratio translates into lower returns and vice-versa. So, if there are two funds with similar track records, you should invest in the one with a lower expense ratio.
Below are the advantages of investing in tax saving mutual funds:
The most notable advantage of ELSS mutual funds is that they allow tax benefits of up to Rs. 1.5 lakhs under section 80C of the Income Tax Act. You can claim your ELSS investments as deductions from your annual taxable income.
By investing in ELSS mutual funds, you allow yourself to earn high returns on your investments. Since these funds invest majorly in equity instruments, they have the potential to provide inflation-beating returns in the long term. Also note that mutual funds are managed by professional fund managers and hence, are less risky.
ELSS mutual funds come with a lock-in period of only three years, which is the shortest among all investment instruments that qualify for tax benefits under section 80C. It means that these funds offer you the maximum liquidity as compared to other 80C investment avenues. You can withdraw your investments anytime after the completion of the first three years.
ELSS mutual funds allow you to take a disciplined approach to investing. You can invest in ELSS funds through a Systematic Investment Plan (SIP) or lump sum. If you opt for the SIP method, you will be able to invest fixed amounts in ELSS funds at a fixed date every month. You can start your ELSS SIP for as low as Rs. 500 per month.
As you know, ELSS mutual funds come with the shortest lock-in period among all other tax-saving investment instruments that qualify under section 80C. Below is a comparison between tax saving mutual funds and other popular 80C instruments, such as Public Provident Fund (PPF), National Pension System (NPS), and Tax-Saving Fixed Deposits (FDs).
ELSS | PPF | NPS | Tax-saving FD | |
---|---|---|---|---|
Returns | 12% to 15% | 7% to 8% | 8% to 10% | 6% to 7% |
Lock-in Period | 3 Years | 15 Years | Till Retirement | 5 Years |
Tax on Earnings | Partially Taxable | No | Partially Taxable | Yes |
ELSS funds or tax saving mutual funds allow you to gain tax benefits of up to Rs. 1.5 lakhs and get superior returns on your investments. However, as an investor, you must consider several factors before making an ELSS investment. These include:
You should always evaluate the risk-return ratio before investing in any instrument and make sure that it aligns with your investment goals and risk appetite. Since ELSS mutual funds are equity-oriented funds, they carry higher risks than other 80C investment instruments. At the same time, they have the capability to deliver superior returns in the long run.
Another thing that you should remember before investing in an ELSS fund is that it comes with a lock-in period of three years. It means that you are not allowed to withdraw your investments in these funds before the completion of the first three years. However, the lock-in period for ELSS is the shortest among all other investment instruments that qualify under section 80C.
You can invest in ELSS mutual funds in two ways - through a Systematic Investment Plan (SIP) or a lump sum method. While an SIP allows you to make fixed investments at fixed intervals, the lump sum method allows you to make one-time investments in mutual funds. You need to select an appropriate method as per your investment needs.
As ELSS mutual funds are categorized as equity-oriented funds, returns from them are taxed accordingly. Any dividend received from these funds is added to your annual taxable income and taxed as per the applicable income tax slab rate. Until 2020, dividends received from equity mutual funds were tax-free in the hands of investors.
Since ELSS funds come with a lock-in period of three years, the probability of getting Short-Term Capital Gains (STCG) is ruled out. Hence, returns from ELSS mutual funds are taxed as per Long-term Capital Gains (LTCG) taxation rules. It means that gains of up to Rs. 1 lakh are tax-exempted, whereas gains exceeding this limit are taxed at a 10% rate without any indexation benefits.
ELSS mutual funds are equity-oriented funds. Hence, they are naturally influenced by market movements. That is why the risks associated with them are usually very high. However, you can easily mitigate these risks by staying invested in the funds for a long term of five years or more. The mandatory lock-in period of three years also helps in reducing these risks.
You can invest in a tax-saving mutual fund online through a mutual fund distributor. What you need to do is create your account by submitting the required KYC documents. You can also invest in ELSS funds through the Moneyfy platform in the following steps:
Step 1 - Visit Moneyfy’s website or download the Moneyfy app on your smartphone.
Step 2 - Create your account and submit the required KYC documents and bank details.
Step 3 - Select the ELSS mutual fund you want to invest your money in.
Step 4 - Make your ELSS investment through any of the available online payment methods.
A Demat account is not required to invest in mutual funds. You can take the help of a mutual fund distributor or broker to invest in tax saving mutual funds. You can make your investment through NetBanking or UPI.
A Systematic Investment Plan or SIP allows you to invest fixed amounts in mutual funds at fixed intervals. SIP is the best method for long-term wealth creation through mutual funds. You can start your SIP in an ELSS fund for as low as Rs. 500 per month. To start your ELSS SIP, you can visit Tata Capital’s Moneyfy platform. Below are the steps you need to follow to invest in ELSS mutual funds through SIP using the Moneyfy platform:
Step 1 - Visit the Moneyfy website or download the app on your smartphone.
Step 2 - Create your investor account by completing your e-KYC.
Step 3 - Select the mutual fund scheme in which you want to start an SIP.
Step 4 - Enter your bank account details and the SIP amount to set up an SIP auto-debit.
Step 5 - Select the date of the first SIP. Your recurring SIPs will be made on this date thereafter.
Step 6 - The SIP amount will be deducted from your bank account every month, and it will get invested in the selected tax-saving mutual fund.
If you want to make a one-time investment in a mutual fund scheme, you will need to opt for the lump sum method of investing. You can make lump sum investments in a tax-saving mutual fund online or offline through the fund house or a mutual fund distributor. To invest a lump sum online, you will need to visit AMC’s website or Tata Capital’s Moneyfy platform. After creating your investor account and completing your e-KYC, you can select the suitable ELSS mutual fund scheme and choose the lump sum option to invest in it. Then, you can make your investment using any of the available online payment methods.
ELSS (Equity Linked Saving Scheme) mutual funds is one of the best mutual funds for tax saving in India. It offers tax benefits under Section 80C and has a lock-in period of three years, providing potential long-term growth.
A mutual fund that provides investment growth along with tax savings is known as a tax-free mutual fund. Investors investing in these can benefit from tax exemptions under specific conditions. ELSS (Equity Linked Saving Scheme) mutual funds are a good option for those seeking funds with tax benefits.