Equity-Linked Savings Scheme (ELSS) funds are a smart investment to have in your portfolio as they help you meet two important financial goals – wealth creation and tax-saving. They offer a range of benefits, and every investor should consider adding them to their portfolio. However, to answer the question – is having exclusively ELSS funds a smart idea – we need to explore this investment product on two levels. First, as a tax-saving instrument, and second, as an equity mutual fund.
ELSS as a tax-saving instrument
- ELSS funds are eligible for a tax deduction of up to Rs 1.5 lakh under section 80C of the Income Tax Act, 1961.
- You can avail of this tax benefit for both lumpsum and Systematic Investment Plan (SIP) investments in ELSS funds.
- ELSS funds are a type of equity mutual fund that invests primarily in equity and equity-linked instruments. Hence, the returns of ELSS funds are market-linked and have the potential of being high.
- Compared to all tax-saving instruments, ELSS funds tend to give the highest returns, of around 15%. Other tax-saving investments such as five-year fixed deposits come with an interest rate as low as 6 to 7%.
- There is a lock-in period of three years, which is the shortest lock-in period amongst all tax-saving investments.
When you look at ELSS funds as a tax-saving instrument, it is a winner. It has the shortest lock-in period and the highest returns. However, it’s never wise to invest in only one type of investment in any category. That’s because different tax-saving instruments are designed keeping in mind different financial goals. When you invest in, say, the National Pension System (NPS), while the lock-in period is still the age of 60, the goal of NPS is to help you build a retirement corpus. Hence, while you should go ahead with ELSS funds, you should also look at other tax-saving options that can help you meet varied goals.
ELSS as an equity mutual fund
Since ELSS is a type of equity mutual fund, it comes with all the benefits of regular equity funds. These include diversification and professional management of funds by an expert fund manager and long-term wealth creation. ELSS funds are the only type of mutual funds that have tax benefits. So, it’s natural to think that if you want to invest in equity mutual funds, you should only opt for ELSS funds as they come with regular benefits plus tax-saving benefits.
Many investors also follow the strategy of – different years, different ELSS funds – to get the section 80C tax benefit each year. However, this is not prudent. There are several types of equity funds based on varied factors. Depending on market capitalization, there are large-cap, mid-cap, small-cap, and multi-cap funds. Based on the investment strategy there are thematic funds, international funds, focused funds, and more.
While all equity mutual funds primarily invest in stocks of companies and other equity-related instruments, the way they do that, and their portfolio composition and fund objective are different. If you want to invest in multiple equity funds, say three equity mutual funds, then it would not be prudent to invest in three ELSS funds. That’s because depending on your financial goals, you can invest in different types of equity funds and optimize your investment portfolio.
The bottom line
ELSS funds are a great investment option, but it is not a smart idea to only exclusively invest in them either as a tax-saving investment or as a mutual fund. Too much of anything never means that its benefits are maximized but rather starts reducing its benefits. Hence, look at building an investment portfolio with an asset allocation that aligns with your goals and risk appetite and covers several asset classes from ELSS funds and pension schemes to fixed-income securities and ETFs.