ELSS vs index mutual funds: Which one should investors choose and why?
Both equity-linked savings schemes (ELSS) and index mutual funds can help investors build long-term wealth through exposure to equities. However, the two investment options differ in their investment approach, tax benefits and suitability for different types of investors.
Investors looking to create long-term wealth have several equity mutual fund options to choose from. Among the more popular categories are ELSS funds and index mutual funds.
Index mutual funds have a considerably larger presence in the industry, with 345 schemes managing assets worth ₹3.20 lakh crore. In comparison, the mutual fund industry has 42 ELSS schemes with a combined assets under management (AUM) of ₹2.53 lakh crore, according to data from the Association of Mutual Funds in India (AMFI).
The two categories also differ in their investment strategies. While index mutual funds are entirely passively managed, ELSS funds can be either actively or passively managed. Until May 2022, ELSS funds were exclusively actively managed. However, Sebi subsequently permitted mutual fund houses to introduce passive ELSS schemes as well.
What should investors choose?
Financial experts believe both categories can serve investors looking to build wealth over the long term. However, the more suitable option depends on an individual's financial goals, risk appetite, investment behaviour and tax requirements.
Preeti Zende, a Sebi-registered investment adviser and founder of Apna Dhan Financial Services, believes an investor's emotional behaviour plays an important role in determining which of the two options to choose.
"Equity investments demand patience and a disciplined long-term approach, and both ELSS and index fund investments need this. The selection of the product depends on your emotional behaviour," she says.
She believes ELSS funds may have an advantage for investors who tend to react impulsively to market movements.
"Both ELSS and index funds are equity mutual funds which help to create long-term wealth. But ELSS can offer better compounding benefits for those who are impulsive in nature -- i.e., who get carried away by two human emotions namely fear and greed. It is generally advised to invest in equity funds for a long time horizon, spanning over a decade at least," she adds.
Nilesh D Naik, Head of Investment Products at Share.Market, also believes the choice should be guided by an investor's individual requirements.
"ELSS funds may be suitable if you are under the Old Tax Regime and looking to avail tax benefits under Section 80C. Most ELSS funds are actively managed, with the goal of outperforming the benchmark index," he says.
Naik adds that investors opting for actively managed ELSS funds should carefully evaluate their track record and investment approach.
"Therefore, it is important to choose the right fund based on a proper assessment of the fund's performance consistency across market cycles, risk, and investment style or philosophy. In contrast, index funds are passive funds which simply aim to deliver returns in line with the benchmark index," he adds.
