What Is the Difference Between ELSS and Mutual Funds?

Introduction

Investing in mutual funds has become the way to grow wealth and achieve financial goals. But within the mutual fund universe there are various categories to cater to different investment objectives. One such category is Equity Linked Savings Scheme (ELSS) which confuses investors who are also considering traditional mutual funds.

Understanding the key differences between ELSS and mutual funds is important to make informed investment decisions. While both help in wealth creation ELSS has additional tax saving benefits. This article will provide a Detailed comparison between the two to help investors decide which one fits their financial goals better.

Start securing your journey towards financial freedom with Entri’s Mutual Fund Course

What Is ELSS?

An Equity Linked Savings Scheme (ELSS) is a type of mutual fund which primarily invests in equity and equity related instruments. The biggest advantage of ELSS is that it provides tax benefits under Section 80C of the Income Tax Act, making it a good investment option for tax saving purposes.

Key Features of ELSS:

• Tax Benefit: Investors can claim deduction up to ₹1.5 lakh per year under Section 80C.
• Lock-in Period: ELSS funds have 3 year lock-in period, the shortest lock-in for tax saving investments.
• High Growth Potential: Since ELSS funds invests in equities they offer higher returns compared to debt based tax saving options like PPF and FD.
• Flexibility in Investment: Investors can opt for SIPs or lump sum investments as per their investment strategy.

What Are Mutual Funds?

A mutual fund is a pooled investment vehicle where fund managers invest in a diversified portfolio of stocks, bonds or other securities. Mutual funds have different types of schemes to cater to different risk profiles and investment goals.

Types of Mutual Funds:

1. Equity Mutual Funds – Invests mainly in stocks, suitable for long term wealth creation.
2. Debt Mutual Funds – Invests in bonds and fixed income securities, ideal for low risk investors.
3. Hybrid Mutual Funds – Mix of equity and debt for balanced risk and returns.
4. Index Funds – Passive funds which tracks a specific index like NIFTY 50.5.
5. ELSS Fund: A special type of equity mutual fund offering tax benefits under Section 80C.

ELSS vs Mutual Funds

ELSS vs Regular Mutual Funds

Advantages of ELSS

1. Tax Benefits: The biggest advantage of ELSS is the tax deduction under Section 80C. Regular mutual funds don’t offer this benefit.
2. Forces Long-term Investment: The three-year lock-in period ensures that you stay invested for the long term, which is often necessary for equity markets to work in your favour.
3. Higher Returns: Since ELSS funds are equity based and have a longer investment horizon, they tend to outperform debt and hybrid mutual funds over time.

When to Choose ELSS

If you want tax benefits along with wealth creation, ELSS is the way to go. It is ideal for:

• Salaried individuals saving tax under Section 80C.
• Long-term investors willing to accept short term volatility for higher growth.
• First time equity investors who want exposure to stock markets with a disciplined approach.

When to Choose Regular Mutual Funds

Regular mutual funds are for investors who:

• Have different investment goals like wealth preservation, liquidity or steady income.
• Want flexibility to choose between equity, debt or hybrid funds based on risk appetite.
• Want to redeem investments anytime without any lock-in period.

Risk Factor: ELSS vs Regular Mutual Funds

1. Market Volatility

ELSS is entirely equity based, so it’s prone to market fluctuations. Regular mutual funds offer low risk alternatives like debt and hybrid funds which are more stable.

2. Exit Flexibility

Regular mutual funds allow you to exit anytime, while ELSS has a 3 year lock-in period, so you can’t access your money during this time.

3. Taxation

• ELSS: Gains above ₹1 lakh from ELSS are taxed at 10% under LTCG (Long-Term Capital Gains).
• Regular Mutual Funds: Taxation depends on the type of mutual fund. Equity funds have same LTCG tax rates, debt funds are taxed based on indexation benefits.

Check your SIP returns with Entri’s SIP Calculator!

Which One to Choose

The choice between ELSS and regular mutual funds depends on your financial goals and risk appetite.

• If saving tax is your priority, ELSS is the obvious choice.
• If liquidity and flexibility matters, regular mutual funds have more options.
• If long term wealth creation is the objective, both ELSS and equity mutual funds can work.

Conclusion

ELSS and regular mutual funds serve different investment needs. ELSS gives you the benefit of dual purpose – tax savings and long term equity exposure, so it’s ideal for tax conscious investors. Regular mutual funds give you multiple investment options with different risk levels, so you have flexibility and liquidity.

Before investing, you need to evaluate your financial goals, risk appetite and tax saving goals. A well diversified portfolio can have both ELSS and other mutual funds to achieve maximum diversification and wealth creation.

Now you know the differences, make informed decisions and maximize your investment. Happy investing!