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Why Top Tax Saving Mutual Funds Should Be Your First Investment Choice?

10 January 20246 mins read by Angel One
A tax-saving mutual fund lets you claim the investments you make in the fund as a deduction from your taxable income. The fund allows you to create wealth in the long term and save tax.
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A mutual fund is an investment vehicle where funds from multiple investors are pooled together and invested in a basket of different assets like stocks, debt instruments or a combination of both. Since the returns are market-linked, investing in a mutual fund may get you closer to achieving your long-term financial goals. 

But what if you could create wealth over the long term and save tax? A type of mutual fund known as Equity-Linked Savings Scheme or ELSS can help you do just that. Read on to know more about this tax-saving mutual fund and why you should consider investing in it. 

What is a Tax-Saving Mutual Fund?

Equity-Linked Savings Scheme (ELSS), also known as a tax-saving mutual fund, is a type of fund that invests primarily in stocks of different companies across sectors and market capitalisations. However, unlike other mutual funds, ELSS has a lock-in period of 3 years. Until this lock-in period expires, you cannot withdraw your investments in the fund. 

However, one major advantage of ELSS funds over other mutual funds is their ability to help you save tax. The investment that you make in an Equity-Linked Savings Scheme can be claimed as a deduction from your total taxable income under section 80C of the Income Tax Act, 1961. Under this section, the maximum amount you can claim per financial year is ₹1.5 lakh. 

Read More About Tax on Mutual Funds

Top Reasons to Invest in a Tax-Saving Mutual Fund

Now that you’re aware of what a tax-saving mutual fund is, let’s look at some of the key reasons why it should be your first investment choice.  

  • Wealth Creation and Tax Savings 

When you invest in a tax-saving mutual fund, you get to enjoy both long-term wealth creation and tax savings simultaneously. Since the fund invests a significant portion of its assets in equity and equity-related instruments, you stand to benefit from the potential high returns associated with investing in the stock market. Furthermore, if you claim ₹1.5 lakh as a deduction from your total taxable income, you can save anywhere from ₹7,500 (₹1.5 lakh x 5%) to 45,000 (₹1.5 lakh x 30%) as tax, depending on your income tax slab rate.

  • Diversified Portfolio 

Most tax-saving mutual funds invest in a plethora of different stocks across sectors and market capitalisations. Such a diversified portfolio helps reduce investment risk and protects your investments from adverse market movements to a certain extent. However, not all ELSS funds have diversified portfolios. Therefore, it is crucial to carefully examine and analyse the fund and its asset allocation before investing. 

  • Short Lock-In Period 

The 3-year lock-in period of the Equity-Linked Savings Scheme is the shortest among all other tax-saving investment options available in India. Here’s a table outlining the lock-in periods for different tax-saving investments.  

Tax-Saving Investment  Lock-in Period
Unit-Linked Insurance Plan (ULIP) 5 years
Tax-Saving Fixed Deposit 5 years
National Savings Certificate (NSC) 5 years
Public Provident Fund (PPF) 15 years

Compared to the other options in the above list, ELSS funds are better in terms of liquidity since they allow you to redeem your investment much earlier.

  • LTCG Benefit 

The gains that you get from equity investments that you hold for more than 12 months are categorised as Long Term Capital Gains or LTCG. As per the Income Tax Act, such Long Term Capital Gains are taxed at just 10%. Furthermore, with LTCG only gains that exceed ₹1 lakh per financial year are taxed. When you invest in a tax-saving mutual fund, all of your gains at the end of the lock-in period are categorised as LTCG, enabling you to make use of these benefits. 

  • Multiple Investment Options 

You don’t always have to invest a large lump sum amount in ELSS. The fund allows you to invest a fixed sum of money regularly for a certain predefined tenure via a Systematic Investment Plan (SIP). When you invest via a SIP, you get the benefit of rupee cost averaging, which boosts your returns by lowering your overall cost of investment. 

Conclusion

Tax-saving mutual funds are a good way to gain exposure to equity and equity-linked instruments. However, it is essential to carefully examine and select the fund that’s right for you. Consider factors like your investment goals, risk tolerance, investment horizon, past performance, risk-adjusted returns and fund manager’s expertise when choosing the right fund. This should help you make an informed investment decision in line with your objectives and expectations.

FAQs

What is the lock-in period for tax-saving mutual funds?

The lock-in period for tax-saving mutual funds like ELSS is 3 years. This effectively means that you cannot withdraw your investments before the expiry of the lock-in period. 

What is the maximum amount of ELSS investment that can be claimed as a deduction under section 80C of the Income Tax Act?

Under section 80C of the Income Tax Act, you can claim a maximum amount of ₹1.5 lakh as a deduction per financial year. Although you can invest more than ₹1.5 lakh in the fund, you cannot claim the amount over ₹1.5 lakh as a deduction. 

Can I start an SIP in an ELSS fund? 

Yes. You can start a Systematic Investment Plan where you invest a fixed sum of money regularly over a specific tenure in an ELSS. Alternatively, you can invest a lump sum amount in the fund as well. 

Is there any risk associated with the Equity-Linked Savings Scheme? 

Yes. Since ELSS funds invest primarily in equity and equity-related financial instruments, they are inherently subject to market risks. Market risk is the risk of an investment losing value due to adverse market movements. 

Are all tax-saving funds similar? 

No. Not all tax-saving funds perform the same or even have similar asset allocations. As an investor, you need to thoroughly evaluate the fund before investing. Look into factors like historical returns, portfolio diversification, and fund managers’ expertise to ensure they are in line with your financial goals and expectations.

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