How do you differentiate Equity funds and ELSS?

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Mutual fund is made up of money that is pooled by a large number of investors who give their money to an asset management company to invest in a large portfolio of stocks, bonds or money market instruments. Affordability, guidance from efficient and professional fund managers, effective diversification, variety and liquidity etc. have made mutual funds an incredibly popular investment option among a wide variety of investors.

Mutual funds invest in two major asset classes, Equity and Debt. An investor can select the asset class based on purpose of investment, duration, liquidity, return, tax advantage etc. Out of their mutual fund investments every investor expects the benefit of capital appreciation, dividend or interest.

Equity schemes:

Equity schemes invest predominantly in equity shares and equity related instruments. Equity funds aim to generate high returns by investing in the shares of different sized companies. The risk, in other words the possibility of stock prices moving up and down is always high, so naturally the risk associated with an equity fund investment will be also on the higher side. The unique behavior of an equity investor is that he is prepared to take the risk in anticipation of making higher returns. His perseverance and patience could bring good reward, so ideally his investment period and objective should be long term in nature. For example a person now plan for his retirement which is actually going to happen after 20 years can choose equity schemes for his investment. On the other hand a person who plans for his daughter’s marriage after 2 years should definitely abstain from equity schemes investments.

An equity fund manager invests in the stocks of companies which are different in size. The sizes of the companies are expressed with the help of a term called “market capitaisation”. This figure is arrived at by multiplying current market price of the stock by number of outstanding shares. After calculating market capitalization of every single company, a rank list will be prepared .Then the companies will be classified as large, mid, small etc. According to SEBI, first 100 companies on the top of the list will be termed as Large cap, from 101 till 250 would be considered as Mid cap while starting from 251 and below are treated as small cap. For equity schemes, this classification is highly significant especially when an investor choose his scheme category. For him, the ideal way is to construct a model portfolio which is a mix  of all categories. This could be done  after considering the parameters such as his age, risk appetite, investment objective etc.

Equity Linked Savings Schemes (ELSS):

ELSS is a type of equity scheme and the prime reason to invest in this fund is to save tax. Section 80-C of the Indian Income Tax Act allows an ELSS investor to avail tax benefits up to 1.5 lakhs. ELSS will  not only help the investor to save his tax burden but it’s unique feature of 3 years lock in period helps the investor to build a habit of investing for a longer period which is an essential quality an equity investor should always possess. Among various tax saving investment options ELSS is becoming so popular because of its shorter lock in period, attractive market linked return and greater flexibility. Investor can choose SIP route also to invest in ELSS. There are many ELSS schemes available in the market which is performing really well. They not only provide excellent return as good as a large cap fund deliver but also provide tax exemption cushion of Rs.1.5 lakhs.

Let’s take an example to understand on how ELSS work as a tax saving investment.

Mr.Ram is a professional and his taxable income is say Rs. 15 lakhs. Now he is coming under 30% tax bracket. Mr. Ram decides to invest Rs. 1.5 lakh in an ELSS fund. Section 80C of the IT Act allows him to deduct  this amount from his taxable income. This will bring down his taxable income to Rs. 13.5 lakh and as a result he could save of Rs. 46,800* (30% tax cut on 1.5 lakhs and 4% education cess on tax cut is also considered.) And do remember… apart from this considerable saving, his principle investment of 1.5 lakhs in equity scheme will also start growing for next 3 years ..!!

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