Mutual funds are one of the most attractive investments. A mutual fund involves the pooling of money in a variety of underlying securities. Units are issued to the mutual fund investors by the mutual fund house. The issue is done in proportion to their investment. Every mutual fund has an investment objective that is set out in the offer document. Profits or losses that arise from mutual funds are proportionately distributed to the unitholders. Only SEBI registered mutual fund houses are eligible to receive funds from the public. There are various types of mutual funds in India. Some of the mutual funds also offer tax benefits. These are popularly known as tax saving mutual funds. Equity Linked Savings Scheme is an example of tax saving mutual funds. ELSS invests the investment money in equity assets only. It is also the only equity investment that offers such an attractive tax benefit. Investments in ELSS can help you to claim a deduction of INR 1.5 lakh under Section 80C of Income Tax Act, 1961.
How do tax saving mutual funds work?
As stated above, tax saving mutual funds allocates the investment money in a variety of underlying assets. The allocation is done in such a manner that the losses incurred, if any, can be mitigated by the profits. Tax saving mutual funds such as ELSS has a lock-in period of 3 years, during which no redemption or transfer of mutual fund units is permitted. You can invest in an ELSS either on a lump sum basis or through SIP. For those who want to avoid the stress of bulk investments, SIP is a preferred option as a specified amount is deducted from the account every month and invested in the scheme. At the time of redemption of ELSS units, only those units that are presently outside the lock-in period are allowed to be redeemed at the current Net Asset Value. The Net Asset Value (NAV) of a mutual fund can provide some guidance about the performance of the mutual fund. NAV represents the market value of the securities held by the scheme. Given that the market value of securities changes every day, NAV of the same scheme may vary on a day to day basis.
Features & Benefits of Tax Saving Mutual Funds
Here are the key benefits of tax saving mutual funds:
- There are no restrictions on the amount that can be invested in ELSS. However, the investments in tax saving mutual funds worth INR 1 lakh are eligible to enjoy the benefits under Section 80C.
- There is a three-year lock in period in case of ELSS. During this time, withdrawal or redemption is not permitted.
- Tax saving mutual funds such as ELSS are open-ended funds. An open-ended fund denotes mutual fund schemes that are continuously available for subscription and repurchase. These funds do not have a set duration of maturity. Investors can buy or sell the units regularly on the basis of NAV. These funds are top-rated among investors who are looking for liquidity alone.
- The total amount of tax benefits offered by tax saving mutual funds is capped at INR 1.5 lakh.
- Tax saving mutual funds are actively managed by a fund manager. These managers are professionals who ensure that the investment goals of the investor are achieved. Before an investment in any tax saving mutual funds, a thorough assessment and analysis is undertaken by the fund house.
- The portfolio of tax saving mutual funds is relatively diverse to minimize the risk from losses.
Does ELSS have a minimum investment amount?
Yes, there is a minimum investment amount. However, the quantum varies depending on the mutual fund house. On average, the amount is pegged at INR 5,000.
What is the NAV of tax saving mutual funds?
In order to determine the performance of a mutual fund, it is worthwhile to examine the Net Asset Value (NAV).
NAV is the market of the securities that are held by the scheme. As these securities are subject to market fluctuation, the NAV of the scheme changes daily. That’s why mutual fund houses publish the NAV of funds daily. In order to determine the NAV per unit of a mutual fund, you need to divide the market value of the securities by the total number of units issued.
For instance, if the market value of securities of a mutual fund scheme is INR 500 lakh and the mutual fund has issued 10 lakh units of INR 10 each to the investors, then the NAV per unit of the fund is INR 50 (i.e.500 lakh/10 lakh).
If I invest in tax saving mutual funds, do I need to pay long term capital gains tax?
Investments in ELSS are exempt from the payment of long term capital gains tax.
What is the average rate of returns offered by tax saving mutual funds?
ELSS typically offers a return of 15%-18%, which is more than what is offered by other popular options like a provident fund or fixed deposits.
Are tax saving mutual funds recommended for an investor who does not have a huge risk appetite?
ELSS is a pure equity investment. It is subject to the performance of the market and is a volatile option. If someone does not have a substantial risk appetite, it would be advisable to consider investments in other avenues that are less volatile such as debt mutual funds.
Are premature withdrawals permitted in case of tax saving mutual funds?
No, you cannot liquidate the investment before the expiry of the lock-in period. ELSS has a mandatory lock-in period of three years.
What are the various types of ELSS funds that one can invest in?
There are two major categories of ELSS: dividend and growth. A dividend ELSS will either provide a dividend payout or an option to reinvest the dividend so that you can purchase fresh equity. In contrast, a growth ELSS acts as a wealth creation tool. There are no dividends received, but benefits are received at the end of the tenure.
Are NRIs eligible to invest in tax saving mutual funds?
Yes, NRIs can invest in these funds.
What is the recommended mode of investments in tax saving mutual funds?
It can vary on the basis of your financial status and investment goals. Monthly investments through SIPs reduce the risk of incurring losses when compared to lumpsum investments.
Rajesh has invested in a debt mutual fund. He wants to change it to tax saving mutual funds. Is this permitted?
It is possible for the mutual fund house to change the nature of the scheme. However, one has to comply with the regulations laid down by SEBI in this regard. As per SEBI, any changes in the fundamental attributes of the scheme, such as the structure, investment pattern, etc., can be changed only when written communication is sent to each unitholder and an advertisement is given in one English daily newspaper having nationwide circulation. The information should also be published in a newspaper published in the language of the region where the head office of the mutual fund is situated. In case the unitholders do not want to continue with the scheme, they have the option of exiting the present scheme at prevailing NAV without bearing exit load.
There are various mutual fund options in the market. How can I choose tax saving mutual funds for investment?
You must start by reading the offer document of the mutual fund scheme very carefully. You should check the track record of the performance of the tax-saving mutual fund. Having said that, it is important to remember that the past performances of tax saving mutual funds are not the sole indicator of their performance. As tax saving mutual funds primarily invest in equity, you should also examine the quality of the portfolio.
Are the companies having names like mutual benefit the same as mutual funds schemes?
One of the common mistakes made by various mutual fund investors is a lack of due diligence. Investors should consider companies that have the words “mutual benefit” affixed to their names as genuine mutual funds. These companies do not come under the purview of SEBI. On the other hand, mutual funds can mobilize funds from the investors by launching schemes only after getting registered with SEBI as mutual funds. Therefore, ask for the details of registration with SEBI and scrutinize the offer document. If you are unsure, seek help from professionals.