Equity Linked Saving Schemes or ELSS offer investors a chance to invest in the equity markets and earn good returns while saving taxes. These equity schemes aim to diversify the risk of investing in stocks by putting in a proportion of funds in debt and money market instruments. Read on to know more about What is an ELSS Scheme and how does it work?

How Does an ELSS Work?

An ELSS is a mutual fund wherein the fund managers invest the corpus money, at least 65% in the equities with the remaining used to buy fixed income or money market instruments. These funds aim to provide maximum capital appreciation over the long run while balancing the risk by investing in less risky options like bonds and other fixed-income options.

These offline and online mutual fund schemes are managed by professional managers who carry out in-depth research before selecting the stocks and other instruments in which to invest. This feature of ELSS makes it highly attractive for novice investors or people who do not have the time to carry out research.

Since these funds aim for capital appreciation, they come with a lock-in period of three years which means investors cannot withdraw their investment before the completion of the lock-in period. This ensures that the investments have adequate time to grow. Experts recommend holding your ELSS investments even after three years if you wish to earn reasonably good returns.

Growth and Dividend Options

Mutual fund companies offer ELSS schemes with two different plans of dividend and growth. When you invest in an ELSS mutual fund, you have the option to obtain a dividend from your investment. If you choose the dividend payout option, you are entitled to get a dividend once the fund declares it.  However, the dividend that you receive from your ELSS investment is included in your taxable income and taxed based on applicable rates.

You can also choose the growth option wherein the dividend declared on your investment is reinvested into the fund.

Come with Tax Advantages

ELSS schemes are popular since investment in them is eligible for exemption under Section 80C of the Income Tax Act 1961.  The tax exemption is available on investments of up to Rs 1.5 lakh in ELSS or other instruments outlined under the Income Tax Act.

Any long-term capital gains that you make on your ELSS investments are taxable as per the prevalent norms.

Encourages Disciplined Investing

You can invest in an ELSS scheme in two ways- by paying a lump sum amount if you have spare resources or through the SIP (Systematic Investment Plan) option. The latter option allows you to commit a small amount that you can save every month or quarter for a predetermined duration. This not only encourages small investors to participate and benefit from the movements in the stock markets but also inculcates a habit of disciplined spending. When you invest via SIP, you get a chance to buy units at different prices and get the benefit of rupee cost averaging.

Now that you are clear about what is an ELSS, you can decide whether you wish to invest a lump sum amount or choose the SIP route. You also need to decide whether you wish to reinvest your earnings or prefer dividend payments as and when the fund announces them.