Tax-saver index funds, also known as equity-linked savings schemes (ELSS) index funds, are a subcategory of ELSS mutual funds, that specifically invests in a basket of stocks that track a particular market index, such as the Nifty 50 or the Sensex. These funds offer investors the dual benefit of tax savings and the potential for capital growth.
How do tax-saving index funds work?
Tax-saver index funds work by investing in a basket of stocks that track a particular market index. This means that the performance of the fund is closely linked to the performance of the index. When the index goes up, the fund goes up, and vice versa.
Tax-saver index funds are eligible for tax deduction under Section 80C of the Income Tax Act, 1961. This means that investors can deduct up to ₹1.5 lakh from their taxable income for investments made in these funds.
Benefits of investing in tax saver index funds
There are several benefits to investing in tax-saver index funds, including:
Tax savings: As mentioned above, tax-saver index funds are eligible for tax deduction under Section 80C of the Income Tax Act, 1961. This means that investors can save up to ₹1.5 lakh on their taxes each year by investing in these funds.
Potential for capital growth: Tax-saver index funds have the potential to generate capital growth over the long term. This is because the funds invest in a basket of stocks that track a particular market index, which means that they are exposed to the growth of the entire market.
Low cost: Tax-saver index funds are typically low-cost mutual funds. This means that investors can keep more of their returns as they do not have to pay high fees to the fund manager.
Diversification: Tax-saver index funds offer investors a diversified investment portfolio. This is because they invest in a basket of stocks across different sectors and industries. This reduces the risk of the investor losing all their money if one particular stock or sector underperforms.
Risks associated with tax saver index funds
Like any other investment, tax-saver index funds also carry some risks. These risks include:
Market risk: The performance of tax-saver index funds is closely linked to the performance of the market index that they track. This means that if the market index goes down, the fund will also go down.
Liquidity risk: Tax-saver index funds have a lock-in period of three years. This means that investors cannot sell their investments in the fund before three years have elapsed.
Illustration of tax-saver index fund
360 ONE ELSS Nifty 50 Tax Saver Index Fund: is an open-ended ELSS fund offered by IIFL Mutual Fund (Now renamed as 360 One). The fund tracks the Nifty 50 index. The investment objective of the fund is to provide investors with capital appreciation over the long term by investing in a portfolio of equity securities that replicates the Nifty 50 index. The fund invests at least 80% of its assets in equity stocks and the remaining in debt and money market instruments.
Navi ELSS Tax Saver Nifty 50 Index Fund: Navi Mutual Fund launched the Navi ELSS Tax Saver Nifty 50 Index Fund on March 8, 2023. The fund is an open-ended ELSS fund that tracks the Nifty 50 index. The investment objective of the fund is to provide investors with capital appreciation over the long term by investing in a portfolio of equity securities that replicates the Nifty 50 index. The fund invests at least 95% of its assets in equity stocks and the remaining in debt and money market instruments.
For what kind of investors are tax-saver index funds suited?
Tax saver index funds are suited for investors who have a long-term investment horizon and who are willing to take on market risk. These funds are also a good option for investors who are looking to save taxes on their income.
Here are some specific types of investors who may benefit from investing in tax-saver index funds:
Salaried individuals: Salaried individuals can invest in tax-saver index funds to save taxes on their income.
Self-employed individuals: Self-employed individuals can invest in tax-saver index funds to reduce their tax burden.
Investors with a long-term investment horizon: Tax-saver index funds are a good option for investors who have a long-term investment horizon of at least five years.
Investors who are willing to take on market risk: Tax-saver index funds are equity-linked funds, which means that they carry market risk. Investors who are willing to take on market risk can invest in these funds to generate potential capital growth.
How to invest in tax-saver index funds
To invest in tax-saver index funds, investors can open an account with a mutual fund company. Investors can either invest a lump sum amount or start a systematic investment plan (SIP). In a SIP, investors invest a fixed amount of money in the fund at regular intervals, such as monthly or quarterly.
Tips for investing in tax-saver index funds
Choose a fund with a good track record: Investors should choose a tax-saver index fund that has a good track record of performance. They should also consider the fund’s expense ratio and the investment philosophy of the fund manager.
Invest for the long term: Tax-saver index funds are a good option for investors who have a long-term investment horizon of at least five years. Investors should not invest in these funds if they need the money in the short term.
Start a SIP: A SIP is a good way to invest in tax-saver index funds as it allows investors to invest a fixed amount of money at regular intervals.
In conclusion, tax-saver index funds are a new innovation in the Indian mutual funds industry. Before the introduction of tax-saver index funds, investors had to choose either tax-saving investments or index funds, however, investors can now choose the best of both worlds. Investors can now achieve tax savings while investing in passive index funds. Though at present only a few mutual fund houses have introduced tax-saving index funds, this number is likely to increase with the passage of time.
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Updated: 13 Oct 2023, 12:37 PM IST