Q. I am a senior engineer working with a business process outsourcing company in Pune. My wife works in the cybersecurity division of the same company. We have been investing in large-cap mutual funds. For tax savings, we have been investing in the National Pension Scheme. We wanted to explore investing inEquity Linked Savings Schemes (ELSS) Mutual Funds. We tried to understand the differences between investing in an Equity Mutual Fund through SIP and in an ELSS Mutual Fund through SIP.
Viraj Karmarka, Pimple Saudagar, Pune, Maharashtra
Introduction
Investing in mutual funds is a popular choice for many Indians due to the potential for high returns, diversification, transparency, and ease of investment. However, understanding the differences between ELSS mutual funds and regular equity mutual funds is crucial for making informed investment decisions.
Difference between ELSS mutual funds and equity mutual funds
Let us understand the differences between ELSS mutual funds and equity mutual funds. We have listed the key differences between the two below:
Definition
Equity: Equity mutual funds primarily invest in stocks of various companies. According to Securities and Exchange Board of India (SEBI) regulations, an equity mutual fund must allocate at least 65% of its assets to stocks and equity-related instruments.
ELSS: ELSS is a sub-set of equity mutual funds, they are a type of equity mutual fund that offers tax benefits under Section 80C of the Income Tax Act. As per SEBI regulations, ELSS mutual funds must invest at least 80% of its corpus in equity and equity-related instruments.
Tax benefits
Equity: Regular equity mutual funds do not provide any kind of tax exemption.
ELSS: ELSS mutual funds provide tax exemption under Section 80C of the Income Tax Act, up to a limit of ₹1.5 Lakh every financial year.
Lock-in period
Equity: Equity mutual funds typically do not have any kind of lock-in period.
ELSS: ELSS mutual funds have a lock-in of 3 years. This means once you invest your money in ELSS funds, it cannot be withdrawn before the completion of the lock-in period.
Active and passive
Equity: Equity mutual funds can be subdivided into two broad categories active mutual funds and passive mutual funds. In the case of active mutual funds, fund managers make a call about the investment decision. They are ultimately in charge of all kinds of investment decisions. In the case of passive mutual funds, the funds replicate the portfolio of an index like the Nifty 50 or Sensex, fund managers do not make any kind of active investment decision on a day-to-day basis.
ELSS: ELSS mutual funds were initially only active, however, in 2024 several passive ELSS mutual funds were launched, once SEBI permitted fund houses to launch passive ELSS mutual funds.
Investment objective
Equity: The primary objective of equity mutual funds is typically capital appreciation. These funds aim to generate high returns by investing in a diversified portfolio of stocks across different sectors and market capitalisations.
ELSS: In the case of ELSS mutual funds the primary objective of the fund is also capital appreciation along with tax saving for the investors.
Risk profile
Equity: Typically a regular equity mutual fund has to invest only 65% of its corpus in equity; the rest of the corpus can be invested in debt or other asset classes to manage risk. It is important to note that although this is generally true there are certain exceptions such as in the case of large-cap mutual funds, 80% of the corpus is invested in the equity of large-cap companies.
ELSS: In the case of ELSS mutual funds, under SEBI regulation, 80% of the corpus has to be invested in equity instruments. This reduces the flexibility available to fund managers typically in the case of equity mutual funds to invest in debt and debt-related securities to manage risk optimally.
Investing in ELSS mutual funds and equity mutual funds through SIP
A Systematic Investment Plan (SIP) is a method of investing in mutual funds that allows investors to contribute a fixed amount of money at regular intervals, such as monthly or quarterly. This approach is particularly popular among investors who prefer a disciplined and systematic way of investing. When you invest in a mutual fund through SIP, you commit to investing a fixed amount of money at regular intervals. This amount is automatically debited from your bank account and invested in the mutual fund of your choice.
In the case of investment in equity mutual funds, investors have more flexibility with their investments. If an investor has invested x amount, 2 months ago and now requires the same amount to take care of an emergency, he can do so by redeeming his mutual funds units. However, in the case of ELSS mutual funds, this flexibility is absent, once the amount is invested in ELSS mutual funds. This is because ELSS funds have a lock-in period of three years.
Benefits of investing in equity mutual funds
It is important to note that investing through SIP in equity mutual funds and SIP have common benefits too, which include the following:
1. Affordability
SIP makes investing in mutual funds accessible to a wide range of investors. With SIP, you can start investing with a small amount, often as low as ₹500 per month. This affordability allows even those with limited financial resources to participate in the equity markets and benefit from potential returns.
2. Rupee Cost Averaging (RCA)
SIP helps in averaging the purchase cost of mutual fund units over time, a concept known as rupee cost averaging. By investing a fixed amount regularly, you buy more units when prices are low and fewer units when prices are high. This averaging effect reduces the impact of market volatility and helps in mitigating the risk of timing the market.
3. Reduced market timing risk
One of the biggest challenges in investing is trying to time the market. SIP reduces the risk of market timing by spreading investments over regular intervals. By investing consistently, regardless of market conditions, SIP helps mitigate the impact of market volatility and reduces the emotional stress associated with market fluctuations.
Performance and returns
Several fund houses in India offer ELSS mutual funds. Below, we have listed the top 5 ELSS mutual funds based on their past 5-year return (CAGR).
| Name | Expense Ratio | 5-Year Return (Compounded Annual Growth Rate) |
| Quant ELSS Tax Saver Fund | 0.50% | 30.94% |
| Bank of India ELSS Tax Saver Fund | 0.95% | 22.84% |
| Motilal Oswal ELSS Tax Saver Fund | 0.64% | 21.23% |
| SBI Long-Term Equity Fund | 0.95% | 23.81% |
| Parag Parikh ELSS Tax Saver Fund | 0.63% | 23.92% |
Source: AMFI; data as of 31st January 2025.
Note: Past returns do not indicate future returns.
Post-budget 2024: Taxation of equity mutual funds vs. ELSS mutual funds
Investing in ELSS or equity mutual funds is a popular choice for many Indians due to the potential for high returns and diversification. ELSS mutual funds are a sub-category of equity mutual funds. However, understanding the taxation of these investments is crucial for maximising returns and planning effectively. The Union Budget 2024 introduced significant changes, let’s dive into them.
Pre-Budget 2024 taxation
- Short-Term Capital Gains (STCG): Gains from equity mutual funds held for less than 12 months were taxed at 15%.
- Long-Term Capital Gains (LTCG): Gains from equity mutual funds held for more than 12 months were taxed at 10% for gains exceeding ₹1 lakh per financial year.
Post-Budget 2024 taxation
- Short-Term Capital Gains: The tax rate for STCG on equity mutual funds was increased from 15% to 20% for transfers made on or after July 23, 2024.
- Long-Term Capital Gains: The tax rate for LTCG on equity mutual funds was increased from 10% to 12.5% for gains exceeding ₹1.25 lakh per financial year.
Impact of the changes
- The increase in STCG and LTCG tax rates may impact short-term investors more significantly. Long-term investors will also see a slight increase in their tax liability, but the higher exemption limit for LTCG ( ₹1.25 lakh) provides some relief.
In conclusion, understanding the differences between ELSS and equity mutual funds under SEBI regulations is essential for making informed investment decisions. While both types of funds offer the potential for high returns, ELSS funds provide additional tax benefits and encourage long-term investment discipline. Investors should consider their risk tolerance, investment horizon, and financial goals when choosing between these two types of mutual funds.
Disclaimer: Investing in mutual funds involves risks, including potential loss of principal. Please consult with a financial advisor before making any investment decisions.
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