It has been well said by Benjamin Franklin that “In this world, nothing can be said to be certain, except death and taxes.”

For most people, tax saving is seen as something that is time consuming and difficult, and is considered an activity that requires massive amount of effort. The very thought of it is enough to make most ordinary investors nervous. However, some lawful means of saving tax exists and the best part about such ways is that they help an individual grow there wealth and save the taxes in process.

Commonly, such tax-saving investment plans come with a lock in period. If you're hoping to save money on taxes, then the best way to do it is to invest.

While you could trod on the tried and tested method of investing in the Public Provident Fund (PFF) or the National Savings Certificate (NSC), you should also try to invest in mutual funds.

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You might be surprised, as you expect taxation on mutual funds - but you need to know where you can invest your money so that you can limit the amount of taxes you pay on it. The best way to go is Equity Linked Savings Schemes or ELSS. They're also rather popularly called tax saver mutual funds.

What’s the big deal about it?

Well, on the lock in period does exist - it is considerably lower than for either the PFF or the NSC. The period is for three years, against the PFF's 15 years and the NSC's 6 years. There are different funds that you can choose from, ranging from those that give your growth or income; depending on what it is you want from the funds. The interest rates are better for ELSS when you compare it to either the NSC or the PFF.

Benefits of investing in ELSS:

  • Income Tax Benefit: With ELSS, investors can get a tax deduction of up to Rs. 1.50 lakhs under section 80C of the Income Tax Act of 1961.
  • Short Lock-In Period: The three year lock-in period of ELSS funds is much shorter than the lock-in periods demanded by other investment avenues like PPF or NSC under section 80C of the Income Tax Act.
  • Tax-Free Dividends/Capital Gains: All dividends that are declared under ELSS are exempt from tax. When ELSS units are sold, the profits made from the sale are considered as long-term capital gains and are tax exempt.

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  • Higher Return: In the case of ELSS funds, a large part of the fund is invested in equity. Equity has the potential to generate wealth in the long run, even though it is affected by short-term volatility.

Investing in an Equity Linked Savings Scheme is a great solution for certain types of investors. If you are an investor looking to generate wealth over a long period of time, then ELSS is a good investment for you. If you are looking to invest in something that will provide you with tax deductions under Section 80C, then ELSS is an investment that should definitely be considered.

Things to consider while investing in ELSS:

When you're looking for a mutual fund to invest in, make sure you compare these factors with each other, so that you get an idea of what you're in for.

  • The expense ratio is an important consideration. It shows how much of your money is going to expenses of the management before the rest goes towards investment. Needless to say, the expense ratio that is lower is better for you.
  • The Sharpe ratio also needs an eye kept on it. This shows the level of fluctuations that the fund undergoes - showing whether or not the decision-making is sound. Sound decisions are likely to give a stable ratio; and less than sound decisions could make the ratio fluctuate madly. So a stable ratio is what you're looking for as far as the Sharpe ratio is concerned.
  • Other than this, you can also choose from the large, mid and small cap investment opportunities. Generally, the large caps are preferred for the ELSS.

Mid-caps and small caps can be quite a risky venture, so if you're investing make sure you have sound knowledge of what you're doing. You need to know your documents well and ensure you do your research before you go ahead and put money in. Because once you've put your money in, you're stuck there for three years.