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Equity-linked saving schemes (ELSS) are usually in demand at the end of a financial year as they offer a maximum tax deduction of up to 1.5 lakh under Section 80C of the Income-tax Act.

Experts suggest that it is wise to start your investments in ELSS funds at the beginning of the financial year as it gives investors more time to evaluate the performance and suitability of the scheme. We take a look if ELSS funds are just a good tax-saving option or it can also help in wealth generation.

An ELSS is an equity-oriented mutual fund, which allocates a minimum of 65% to equity and the rest to debt instruments. ELSS funds are the only mutual fund schemes that come with tax deduction benefits.

A person in the highest income tax bracket of 30% can save up to 46,800 a year in taxes by investing up to 1.5 lakh in ELSS mutual funds.

Another aspect that works in their favor is that ELSS plans have the shortest lock-in period of just three years, but there’s no compulsion on investors to exit these funds after this period.

Over the last five years, ELSS funds have delivered an average return of around 13.32% against NPS’ (National Pension System) similar kind of returns for its equity funds, while safer tax-saving options such as Public Provident Fund (PPF) are currently offered 6-7% kind of returns. However, NPS and PPF have a much longer lock-in period.

“Investors can definitely look at ELSS as a wealth creation instrument," said Rushabh Desai, founder of Rupee With Rushabh Investment Services. “Tax saving has two parts, one is the equity segment and the other is the fixed income segment. So, investors should keep in mind their goals risk appetite and time horizon when choosing a tax saving product," he added.

While ELSS funds have a lock-in period of three years, experts suggest staying invested in the fund for at least five years.

“The main reason is equity is a very volatile asset class right. The longer investors stay invested, the longer their money gets compounded, and they can get optimum returns in equities," Desai said.

Mind that when investing at rich valuations, equity funds such as ELSS might take more time to deliver decent returns.

Further, ideally, investors already having a well-diversified equity portfolio should have just one ELSS fund.

When it comes to 80C, apart from ELSS, the section also allows deduction for investment made in small savings schemes, life insurance premium, and principal amount payment towards home loan.

Therefore, it would be unwise for an investor to go for an ELSS fund, if he or she has already exhausted the 1.5 lakh limit under section 80C on other instruments.

While ELSS funds have delivered decent returns in the recent past, investors should be careful in having more than one ELSS fund in their portfolio.

What should investors do?

Remember that ELSS is an equity fund, therefore, it is better to go for periodic systematic investments based on one’s risk appetite and time horizon. If an individual's existing portfolio is more inclined towards growth, then he or she should choose a value-oriented ELSS, and vice-versa. Investors should also look at the underlying portfolio whether the ELSS fund is more skewed towards large, mid or small caps.

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