Mutual funds are growing popular day by day in India. The investment solutions offer investors the chance to benefit from experienced, trained investment managers and grow their wealth. Mutual funds are attractive for those who don’t want to invest their time in filtering stocks.
But what if I tell you that you can get tax benefits for investing in mutual funds?
Yes! It is possible to achieve this by investing your funds in a tax-saving mutual fund.
What are Tax Saving Mutual Funds?
Tax-saving mutual funds are like other mutual funds with tax benefits. These mutual funds are eligible for tax benefits under section 80C of the Indian Income Tax Act. Most of the tax-saving mutual funds come under ELSS Schemes.
Here is the list of the top 10 Tax saving mutual funds:
| Mutual Funds | 1Y Returns |
|---|---|
| SBI Long term Equity Fund | 59.20% |
| Quant ELSS Tax saver fund | 57.09% |
| Bank of India ELSS Tax Saver Fund | 54.88% |
| Motilal Oswal ELSS Tax Saver Fund | 48.19% |
| HDFC ELSS Tax Saver Fund | 45.28% |
| Bandhan ELSS Tax Saver Fund | 38.15% |
| Nippon India Tax Saver Fund | 38.12% |
| Kotak ELSS Tax Saver Fund | 36.55% |
| Invesco India ELSS Tax Saver Fund | 35.19% |
| HSBC ELSS Tax Saver Fund | 34.95% |
How do Tax Saving Mutual funds work?
When an investor invests in a mutual fund, this capital is added to the pool. It is not invested in a single sector but in a variety of sectors. The logic behind investing in diverse sectors is that if a sector declines due to any reason other sectors will manage the losses. This is called balanced Investing.
For example, the breakup of investment in Shriram ELSS funds looks like this:
| Private Sector Banks | 10.77% |
| Software | 10.45% |
| Refineries and Marketing | 7.35% |
| Pharmaceuticals | 7.03% |
| Power Generation | 5.53% |
| Financial Institution | 5.38% |
| Civil Construction | 4.92% |
The above table shows how funds distribute money into a variety of sectors such as 10.77% of investment is done in private sector banks and 10.45% in the software Industry.
What is the Lock-in Period?
In ELSS, the lock-in period is of three years. It means you cannot withdraw your money up to the maturity period of three years. If you have invested your money in systematic monthly installments(SIP), then the lock-in period will be three years for each installment.
For Example, if you submit the first installment on 1 February 2024 and the second installment on 1 March 2024. Then you can withdraw the returns of the first installment after 1 February 2027 and the returns of the second installment after 1 March 2027.
Types of ELSS(Equity-linked Savings Schemes)
Two types of schemes come under ELSS: Dividend Scheme and Growth Scheme.
- In a dividend scheme, an investor gets an extra income in the form of a dividend declared by mutual funds from time to time.
- In a growth scheme, an investor can withdraw their capital and gain after the maturity period only.
Benefits of Tax Saving Mutual Funds
There are several benefits of tax-saving mutual funds that are:
- Tax Benefits: Tax benefit is one of the best benefits of tax-saving mutual funds. Under section 80C of the income tax, 1961 investors can claim tax relaxation of up to 1.5 Lakhs as investments in a financial year. This claim amount is fixed but you can invest as much as you want.
- Diversification: Most of the ELSS funds follow the rule of diversification. These funds invest in a variety of companies from large-cap to mid-cap and across various sectors.
- Liquidity: These mutual funds(ELSS) provide good liquidity due to their lock-in period of three years.
- Higher Returns: Tax Saving mutual funds(ELSS) provide higher returns due to their equity exposure. This exposure makes them a great choice to invest in compared to other tax-saving schemes like PPF(Public Provident Fund) and NPS(National Pension Scheme).
- Mode of Investment: Tax Saving Mutual funds provide two modes of Investment i.e., Lumpsum and SIPs. Lumpsum is for those who want to invest in large amounts or one-time investments. If an investor wants to add a small amount in a systematic time order then SIPs are best for that.
What should you choose SIP or Lumpsum?
If you have a surplus amount and want to invest in one mode then lumpsum is an ideal choice for you. But if you have a small amount and you want to add it to the fund every month then SIP is the best option.
According to me, investing via SIP is a great option if you are not willing to take a higher risk. Let me show why SIP is better than lump sum. Suppose you invested Rs 1.5 lakhs via lumpsum and the market went down after that. In that case, you cannot control the return on your invested amount.
But if you are investing through SIP, then you will have a chance to invest a higher amount when the market is down to get higher returns. You will get the benefit when the market will go up. This benefit is not available when you invest via lumpsum.
But In case the market is already in bear mode, in that case, lumpsum will work as SIP. So Investing according to the market cycle is advisable.
Comparison among Tax saving Funds
There are various tax-saving schemes are available in markets like FD, PPF, NPS, and NSC. But returns in every fund are different. Here ELSS stands out due to higher return in comparison to other schemes. Let’s explore each of the schemes:
| Investment | Returns(%) | Lock-in Period | Tax on Returns |
|---|---|---|---|
| Bank Fixed Deposits(FD) | 4 – 6 | 5 Years | Yes |
| Public Provident Fund(PPF) | 7 – 8 | 15 Years | No |
| National Saving Certificate(NSC) | 8 – 10 | 5 Years | Yes |
| National Pension Scheme(NPS) | 8 – 10 | Till Retirement | Partially Taxable |
| ELSS | 15 – 18 | 3 Years | Partially Taxable |
