ELSS vs mutual fund – Are they different?

Do you know the difference between a cake and an ice-cream cake? An ice-cream cake is essentially a cake that lets you experience the joy of eating an ice-cream as well. Now coming to the discussion of ELSS vs mutual fund, ELSS or Equity Linked Savings Scheme is also a mutual fund in essence but it lets you enjoy tax benefits as well. How? Let’s find out.

ELSS vs mutual fund: Understanding the difference

Yes, ELSS is a mutual fund investment.  As you know, a mutual fund pools the money of different investors and invests it in different securities to earn profits. Broadly, there are three types of mutual funds – Equity funds, debt funds and hybrid funds. While equity mutual funds invest in stocks, debt mutual funds invest in debt securities that offer a fixed rate of interest. On the other hand, hybrid mutual funds invest in a mix of equity and debt. 

ELSS is a type of equity mutual fund but with two differences – tax saving and lock-in period. Let’s understand these two parameters.

With ELSS, you can have the cake and eat it too!

ELSS is the only tax-saver mutual fund in India. When you invest in ELSS, you can reduce your taxable income up to Rs 1.5 lakh annually under Section 80C of the Income Tax Act,1961. This means you can save up to Rs 46,800 in taxes each year. But you must remember that ELSS is unlike other open-ended mutual funds where you can withdraw your money anytime. This is because this equity fund has a lock-in period of three years. You can withdraw your money only after the end of three years.

That said, here are some reasons apart from tax savings that make ELSS a good investment option.

Benefits of ELSS

1. You can beat inflation: ELSS is essentially a diversified equity mutual fund that invests in companies across market capitalisations and industry sectors. Equities have the potential to offer inflation-adjusted returns in the long run.

2. It has the shortest lock-in period: ELSS can be an effective tax-planning tool. It has the shortest lock-in period of three years as compared to other tax-saving investments under Section 80C. For example, Public Provident Fund (PPF) has a lock-in period of 15 years.

3. You get investment flexibility: Other tax-saving investments such as 5-year Fixed Deposits (FDs) allow you to make a one-time investment. However, with ELSS you have two options. You can either make a one-time lump sum investment or you can invest through Systematic Investment Plans (SIPs). The latter allows you to invest in parts regularly at your chosen frequency.

4. You get better post-tax returns: Since ELSS is an equity mutual fund that allows you to withdraw your money only after three years, your gains on redemption will by default attract long-term capital gains (LTCGs) tax. LTCGs up to Rs 1 lakh/year are tax-free. Anything above that will be taxed at 10%.

To sum it up

ELSS is a type of mutual fund. It differs from other mutual funds because of its tax benefits as well as the lock-in period. Being an equity mutual fund, it offers several benefits that make it a suitable mutual fund investment for long-term goals.

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