What Are ELSS Funds? Everything You Need To Know

Vinod Desai

4 years ago

TL-DR: What are ELSS Funds? How are they different from regular funds? And how does one invest in them? This is a re-do of multiple old posts which were’nt well organized.

What Are ELSS Funds?

You invest in businesses using stocks.
An equity mutual fund invests your money into stocks of multiple businesses.

An ELSS, is a special kind of equity mutual funds.

It helps you save taxes. Your investment into it qualifies for deduction under Section 80C.
An ELSS fund primarily invest in large-caps and blue chips.
Since they’re intended to help you save money for our future, these mutual funds are also called Equity Linked Savings Schemes – ELSS for short.

Is that the only difference?

There’s more.

ELSS funds have a 3 year lock-in

The most common type of equity mutual fund (which goes by the full name of ‘Open-ended equity mutual fund) has no lock-ins. Which means you can invest today, and as long as you are willing to pay an exit load, you can withdraw the next day.

This doesn’t mean you should. The point is that your investment isn’t locked in.

On the other hand, despite technically being an open-ended, an equity mutual fund has a 3 year lock-in. Units you purchase today, will only be available to you 36 months later.

What happens after 3 Year lock-in?

You’ll be able to sell the units which have finished 3 years.
There are no restrictions thereafter. It’ll then behave as any other non tax-saving mutual fund.

Is there a difference in the way an ELSS fund invests money?

No. Other than the tax-saving advantages and the three year lock-in, an ELSS fund works like any other diversified equity mutual fund.

Who should invest in ELSS funds?

To invest in them, and not be stressed about the decision, you need to be prepared for all these criteria.

You absolutely don’t need the money you’ve invested over the next 3 years

In the first 3 years, you have no access to your money whatsoever. It’s a complete lock.
If you’re investing monthly using an SIP, the units you picked up at the end of your SIP, will move out of lock-in 3 years later. FIFO. Get?

You don’t need most of that money over the next 7 years

Equity investments( tax-saving, stocks, mutual funds or otherwise) aren’t like FDs. They aren’t supposed to go up day after day, year after year.
Sure they generate better returns than other asset classes, but they take time.
During this time, your investment may grow very little, shrink in value or grow a lot. There’s no way to predict a market recession, a correction or a crash.
Even economists and financial pundits can’t — case in point, they predicted a recession each year for the last 10 years.
So over these five to seven years, you should be comfortable with the idea that your money hasn’t grown, or that it’s even reduced in its value.

You understand equities reasonably well

If not, there’s a likelihood you might be in for much disappointment. They might seem harmless because they’re tax saving investments and quite popular. But they carry the same risks as any other equity investments.

Can you start an SIP into an ELSS fund?

Of course. But there’s an often overlooked catch.

We already know that any units you purchase will be locked in for 36 months. In these 36 months, you have no access to them whatsoever.

Now when you start an SIP, you buy units every month. Each month’s units are locked-in for 36 months.

So August 2020 units will be available to you after August of 2023.
The units you picked up in September 2020 will be available to you after September of 2023.

Taking this further, if you are starting a 3-year SIP in an ELSS fund, the units you picked up in the 36th month will free up after a further 36 months. Which technically means, in total, by the time you have access to all your units, it’ll be about 6 years.

Should you sell your investments in them after the 3 year lock-in?

There is no reason to liquidate an ELSS mutual fund, just because it’s out of the 3 year lock-in period. The point being, that selling off or liquidating any of your investments should be based on your goals.

After the 3-year lock-in, nothing about the fund changes fundamentally. The fund manager still runs the fund the same way as he/she did earlier. So if the fund has continued to perform well, you can stay invested and let the money grow.

Equities work best when you stay invested for the long term. And history has proven that the longer you stay invested, the better. To see what happened to 1 Lakh of investment, when it was left untouched for 20 years, despite the stock market witnessing several minor and at least one major crash, see this post here.

So unless you need the money to fund an immediate goal, stay invested. And if your need is say three years down the line, you are better off moving it to a debt mutual fund or an FD, depending on your appetite for risk. Remember though, that debt mutual funds and debt products like FDs are a good way to protect your money, and not necessarily to grow it. You’ll need to strike a balance, depending on how much of it you can let grow, and how much you need to protect. This answer applies to any equity mutual fund investments; not just to ELSS funds. Always invest/liquidate based on needs and goals.

Which are the top performing ELSS funds today?

Go here, sort by rating, and to start with pick any ELSS fund which has a 5 or 4 star rating.

Which sites should you use to invest in ELSS funds?

You can use any of the sites on this list here. They provide access to direct plans of mutual funds.

Don’t know what ‘direct plans of mutual funds’ are?

Then read this here.

A lot of the words here are unfamiliar to me. I want to understand this better.

To understand everything about ELSS funds, you’ll need to know the fundamentals of equities and equity investing. And then you’ll need to learn about mutual funds in general.

I understand gathering this knowledge can be tricky. An article here, a Youtube video there. But if you’re keen on building that foundation, pick up a copy of the book you see below. I promise your future self will thank you.

Until the next time, happy moneyplanting.

Vinod