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With only a few more days left in this financial year, there’s a last-minute rush to explore and invest in the various instruments that help limit tax outgo under the Income Tax Act.

One such option is Section 80C, which offers a maximum tax deduction of up to 1.5 lakh in a financial year. You can claim tax benefit under this section against investments such as Public Provident Fund (PPF), equity-linked savings schemes (ELSS), Sukanya Samriddhi Yojana (SSY), National Savings Certificate (NSC) and Senior Citizens Savings Scheme (SCSS) as well as payments made towards the principal sum of a home loan and life insurance premiums.

ELSS funds are the only mutual fund schemes that come with tax deduction benefits and they can potentially offer the best returns among other 80C options
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ELSS funds are the only mutual fund schemes that come with tax deduction benefits and they can potentially offer the best returns among other 80C options

Among the many options available to investors, ELSS mutual funds have the shortest lock-in. We tell you the benefits of investing in these schemes and the important things to keep in mind:

What are ELSS funds?

An ELSS fund is an equity-oriented mutual fund, which allocates a minimum of 80% to equity and the rest to debt instruments.

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.

The gains on such funds are treated as long-term capital gains (LTCG). Gains above 1 lakh per annum are taxed at 10%.

However, there is no cap on investments in these schemes. Another aspect that works in their favour 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 14-17% against a similar kind of returns from the National Pension System (NPS), while safer tax-saving options such as PPF have offered returns in the 7-8% range. Moreover, NPS and PPF have a much longer lock-in period.

“ELSS investments get locked in for three years, which makes it impossible for an investor to do anything about concerns over volatility. Whatever happens to the market, investors have to grin and bear it and let the fund do its thing and grow," said Srikanth Meenakshi, co-founder of Prime Investor, a mutual fund research portal.

Keep in mind that any equity fund will have volatility, but one can mitigate this volatility risk by investing for the long-term such as at least for five-to-seven years.

“If you see, for a time period of 10-15 years, the safest product such as PPF gives 7.1% post-tax return. If anyone is invested in equity and they get 10% return and post-tax around 9%, then the spread will be around 2%. Generally, for retail investors who are not savers in equity, ELSS is the best option," said Nishith Baldevdas, founder of Shree Financial and a Securities and Exchange Board of India (Sebi)-registered investment adviser (RIA).

How to choose a fund

Financial experts look at fund ratios, portfolio churn and assets under management, but these parameters might be difficult for an investor to check.

“For a layman, first, he or she needs to understand the risk appetite, then the person should see the maximum return they look for and the worst loss they can handle and based on that they should look at good fund houses and fund managers," said Baldevdas.

Remember that investing in one or two ELSS funds is enough on a yearly basis, given their diversified nature.

Keep in mind

Like any equity mutual fund, a systematic investment plan (SIP) is a good way to invest in ELSS funds. SIPs invest a fixed amount in a mutual fund every month and average out the buying price. If you are investing a lump sum, do not wait till the last day of the financial year.

According to new Sebi rules, in terms of funds realization, if the investment is made on 31 March, the funds might not get realized till 2 April and the net asset value (NAV) will not be allotted till then.

So, there is a possibility that the investment date will be considered past 31 March 2021, and it will not be counted for this fiscal year.

“Recently, Sebi changed the rules saying that the NAV date for any equity mutual fund investment will be the date on which the scheme realizes the funds in its account. The safe option is to invest by Friday (26 March), so that investors safely get the allotted units before 31 March and the investment as well as the NAV allotment date is before March-end," said Meenakshi.

ELSS funds may have beaten returns from other tax-saving options in the past, but investors should be reasonable with their return expectations as past returns may not be repeated.

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