Active vs passive ELSS: Which is better for tax savings?

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Mutual funds can be divided into two based on how they are managed – active mutual funds and passive mutual funds. As the names suggest, active mutual funds are actively managed, and passive mutual funds follow a predefined benchmark as their portfolio.

But few people know that Equity Linked Savings Scheme (ELSS), an equity-focused tax saver mutual fund, has both active and passive choices. Let us learn more about ELSS, its active and passive options, and see which could save you more tax.

What is an ELSS fund?

ELSS is a form of mutual fund that enables you to save on your income taxes. Investing in ELSS, as recognized by Section 80C of the Income Tax Act of 1961, may provide tax savings of up to 1.5 lakhs per year.

ELSS works similarly to that of any other mutual fund. It pools money from different investors to invest in a portfolio that matches the fund’s theme. Since ELSS is equity-focused, at least 65% of its portfolio will be dedicated to equities. That makes all ELSS funds equity mutual funds. At the same time, it is important to understand that not all equity funds are ELSS funds. The main difference is ELSS’s three-year lock-in period.

Active vs passive ELSS

Active ELSS is managed by a professional money manager or team of money managers who choose which securities to purchase and sell to generate returns for investors. In contrast, a passive mutual fund aims to replicate the returns of a market index, such as the Nifty 50, by replicating its performance.

An important distinction between active and passive ELSS is their investment strategies. Active funds are often managed to outperform the market, whereas passive funds seek to mirror the performance of the market. As a result, active funds may take on greater risk to earn better returns, whereas passive funds are often less risky and may have lower returns.

Another important distinction between the two types of funds is their fees. Because the managers need to be compensated for their investment decisions, active funds often have higher management fees. In contrast, passive funds often have lower management fees since they require less active management.

Active vs passive ELSS – Which is better?

Active funds can provide better returns than passive funds if the investment decisions of their managers are effective. Unfortunately, this is not always the case, as active mutual funds can underperform the market if the managers’ judgments are unsuccessful.

On the other hand, passive funds provide investors with exposure to the entire market, which can be advantageous in a diversified portfolio. They can also be an excellent option for investors seeking a low-cost investment vehicle, given their management fees are often lower than those of active mutual funds.

Active vs passive ELSS – Which saves more tax?

One of the primary advantages of investing in ELSS is that it allows you to reduce your tax liability under Section 80C of the Income Tax Act. This clause permits a deduction of up to Rs. 1.5 lakhs for investments in certain designated securities, such as ELSS. This means you can lower your taxable income by the amount invested in ELSS.

But the amount of tax saving is the same for both active and passive funds. This is because the amount of money invested is the only parameter of tax savings through ELSS funds.

Conclusion

Active and passive ELSS are two distinct types of investment vehicles, each with their own characteristics and risks. Therefore, before determining which sort of fund is suitable for you, you should carefully assess your investment objectives and risk aversion.