ELSS vs Mutual Funds: Difference Between ELSS and Mutual Fund

Mutual funds are marketable securities that pool money from investors and invest in different asset classes. ELSS or Equity Linked Savings Schemes are equity mutual funds that invest a majority of the assets in equities. Both mutual funds and ELSS operate in the same way. However, there is one major difference between mutual funds and ELSS.

Read our article “ELSS vs Mutual Funds” to find out how ELSS is different from mutual funds and which one is a better choice.

What Are Mutual Funds?

A mutual fund is a financial instrument that pools money from investors and invests in different securities such as stocks, bonds, government securities, commodities, money market instruments and other assets. A fund manager manages a mutual fund and is responsible for investing the investor’s money in different securities based on the fund’s objective. The fund manager does thorough market research and selects the securities for the fund, and also revises the portfolio based on the market conditions. For managing the mutual fund, the fund manager charges a small fee called expense ratio which is deducted from the profits of the fund.

Since mutual funds invest in a bunch of securities, it gives small investors access to diverse securities at a minimum investment. Each investor will get units of the mutual funds based on their investment. Each unit is valued equally and is calculated by dividing the total assets by the total number of units. This value is also known as net asset value (NAV). The NAV of the fund goes up when the mutual fund makes a profit, and it goes down when it makes a loss.

There are several types of mutual funds in the market based on the underlying asset classes, namely, equity mutual funds, debt mutual funds, and hybrid mutual funds. Equity mutual funds invest the majority of the assets in shares of different companies. They have a very high potential to give good returns in the long term. However, they are also the riskiest category of mutual funds. Debt mutual funds invest most of their assets in debt securities such as bonds and debentures. They are the least risky category and often give predictable returns to investors in the short term. However, their returns are lower than equity funds.

What Is ELSS?

Equity Linked Saving Schemes (ELSS) funds are equity mutual funds that invest at least 60% of their assets in shares. Hence, they are considered a risky investment. However, they can help accumulate wealth in the long run. The primary advantage of investing in ELSS is that the investment qualifies for tax deduction under Section 80C of the Income Tax Act, 1961. You can claim a deduction of up to Rs 1.5 lakhs under Section 80C. This is the major difference between ELSS and other categories of mutual funds.

ELSS funds come with a lock-in period of three years, so you can’t redeem your investment until the three-year period ends. In case you are doing a SIP (Systematic Investment Plan), each instalment is considered a separate investment and has to complete three years for you to redeem it.

ELSS funds offer the dual advantages of tax saving and capital appreciation. Investors looking to save tax and invest can consider these funds. Since these funds are pure equity funds, you must be careful before investing in them. You must have a high-risk tolerance and a long-term horizon to invest in ELSS funds. Moreover, you must align your goals with the fund’s investment objective to find the best fund that will suit your requirements.  

Similarities Between ELSS and mutual funds

Before understanding the differences between ELSS and mutual funds, let’s see the similarities between the two.

• Fundamentals: The concept of mutual funds and ELSS is the same. The money is pooled from investors and invested in different asset classes. The fund managers manage the portfolio of the mutual fund. This means they do market research select stocks, invest, and periodically review the portfolio. They are also striving to make higher returns in different market scenarios. When the underlying asset classes’ value increases, the mutual fund makes a profit, and if it goes down, it makes a loss.
• Investment: You can invest in mutual funds and ELSS either through lumpsum mode or through SIPs.
• Expense ratio: Mutual funds and ELSS charge a small fee called expense ratio from the investors to cover fund transactions, distribution, and administrative costs.
• Exit load: Mutual funds and ELSS have an exit load or penalty if the investor redeems the investment one year from the time of investment.
• Taxes: ELSS and mutual funds are both taxed similarly. Since ELSS funds are equity funds, they are taxed as per equity mutual fund norms. The short-term capital gains (gains made before one year) are taxable at 15%, and the long-term capital gains above Rs 1 lakh are taxable at 10%. In the case of debt mutual funds, the short-term and long-term capital gains are taxable at the investor’s income tax slab rate.
• No auto redemption: Both mutual funds and ELSS have to be redeemed by you. Until and unless you redeem them, you will stay invested in these funds. There is no maturity period, nor the investment proceeds will be directly credited to your bank account after a certain tenure.

Difference Between ELSS and Mutual Funds

Equity Linked Saving Scheme (ELSS) is a form of Mutual Fund in which equity investments are made. The primary distinction between an ELSS and a traditional Mutual Fund is the tax benefit that an investor receives for participating in an ELSS.

ELSS vs Mutual Funds

The following are the difference between ELSS and mutual funds:

To conclude

The only major difference between ELSS and mutual funds is the tax deduction and lock-in period. If you are looking for an investment plus tax saving option, ELSS funds can be considered. However, before investing in ELSS or mutual funds, you must consider your investment horizon, risk appetite, goals, and financial resources.

Frequently Asked Questions

1. What Is Better SIP or ELSS?

   SIP stands for Systematic Investment Plan, and it means investing in an asset in regular periodic intervals. It is not a type of investment but a mode of investment. You can invest in mutual funds or ELSS through SIP or lumpsum. SIP is a better choice if you are a regular salaried professional who wants to save a little every month. You can also choose the lumpsum mode. However, it is best suitable when you have excess cash, such as a bonus or gift.

2. What happens to ELSS After 3 years?

   At the end of three years, the ELSS funds do not have a lock-in period. Hence, they are liquid enough for you to withdraw them at any time. This doesn’t mean that after three years, your investment proceeds will be credited to your account. You will remain invested in them until you withdraw your investments.

3. Is ELSS Taxable after 3 years?

   Investment in ELSS qualifies for tax deduction under Section 80C. However, capital gains are taxable when you redeem them. Since ELSS funds are equity funds, their taxation is similar to them. However, there is no short-term capital gains tax for them as the lock-in period is three years. The long-term capital gains above Rs 1 lakhs are taxable at 10%. Capital gains up to Rs 1 lakh are exempted from tax.

4. Is ELSS High Risk?

   Yes, ELSS funds are risky funds since they invest majorly in equity. In the short term, ELSS funds are prone to market volatility. However, since your investment is locked in for three years, they are considerably less risky than other equity funds. In the long term, they have the potential to give good returns.

5. What Are the Disadvantages of Investing in ELSS?

   The primary disadvantage of ELSS funds is that the investment is locked in for three years. So, the liquidity is low. In case the fund underperforms its peers, you have to wait for three years to redeem it or switch your investment.