Mutual fund investing comes with its own set of benefits as well as disadvantages, just like any other investment option in the market. Here, we will discuss about investors who want to save taxes while creating wealth for the long term at the same time. For them, there is a special category of equity funds called as the ELSS mutual funds. These are a popular category when it comes to mutual fund investing as it offers dual benefits to investors, convenience of investing, flexibility as well as complete transparency in the process.
Benefits of Investing in Tax-Saving Mutual Funds
Potential for Higher Returns
Since ELSS funds primarily invest in equities, they have the potential to deliver higher returns over the long term, outperforming traditional fixed-income tax-saving options.
ELSS funds invest in a diversified range of stocks across sectors and market capitalizations, reducing the risk associated with investing in individual stocks.
Investors can start investing in tax-saving mutual fundschemes with a relatively small amount, either through lump-sum investments or through Systematic Investment Plans (SIPs). SIPs allow for regular and disciplined investing, helping in rupee cost averaging.
The returns from ELSSmutual fund investment are treated as Long-Term Capital Gains (LTCG) after the completion of the three-year lock-in period. Currently, LTCG up to Rs. 1 lakh in a financial year is exempt from tax, providing an additional tax advantage. Long term gains beyond Rs 1 Lakh is taxed at only 10%.
Disadvantages or risks of ELSS mutual funds
After understanding the various benefits of making an ELSS investment, here are a few risks involved in undertaking tax saving mutual funds as an investment option –
No Guaranteed Returns
ELSS funds, like any other equity investment, do not guarantee returns. The performance of these mutual funds is subject to market fluctuations and the performance of the underlying stocks in the portfolio. There is always a level of uncertainty associated with equity investments, and investors must be prepared for the possibility of negative returns, especially in the short term.
Sector and Stock-Specific Risks
ELSS funds invest in a diversified portfolio of equities; however, they might have exposure to specific sectors or stocks. If a significant portion of the fund’s assets is concentrated in a particular sector that faces challenges, the overall performance of the fund may be adversely affected.
Performance Variation among Funds
ELSS funds are offered by various asset management companies (AMCs), each with its own investment strategy and fund management skill. As a result, the performance of different ELSS funds can vary significantly. Investors must conduct thorough research and select a fund with a consistent track record and alignment with their risk tolerance and financial goals.
Limited Investment Window for Tax Deduction
ELSS funds are eligible for tax deductions under Section 80C of the Income Tax Act, up to a maximum of Rs. 1.5 lakh in a financial year. Consequently, investors looking to invest larger amounts for tax-saving purposes may need to explore other investment options beyond ELSS.
To minimize risks, investors should diversify their portfolios, adopt a long-term investment horizon, and invest according to their risk appetite and financial goals. Additionally, seeking advice from a qualified financial advisor or a mutual fund distributor can help in making well-informed decisions and aligning investments with individual needs and circumstances. As with any investment, careful evaluation and due diligence are essential to maximize the potential benefits of investing in ELSS mutual funds while mitigating the associated risks.