Traditionally, ELSS funds were actively managed by fund managers. However, with the growing interest in Index Funds, Asset Management Companies (AMCs) are now launching Passive ELSS Funds to provide a cost-effective alternative to investors.

In this blog post, we’ll delve into what ELSS index funds are and explore why passive funds are becoming increasingly popular in today’s investment landscape.

What is an ELSS Fund?

ELSS, or Equity Linked Savings Scheme, is a type of mutual fund that primarily invests in equity assets and comes with a minimum lock-in period of 3 years.

These funds offer investors the benefit of tax deductions under Section 80C of the Income Tax Act, 1961.

Tax Saver Index Funds combine passive investment strategies with the key features of actively managed ELSS funds, including tax deductions of up to Rs 1,50,000 under Section 80C and a relatively short lock-in period of 3 years compared to other tax-saving options.

Understanding Index Funds

Index Funds typically invest in stocks mirroring a specific stock market index, such as the Nifty or Sensex. Unlike actively managed funds, Index Funds follow a passive investment approach, where the fund manager invests in the same securities as the underlying index, maintaining the same proportions.

Passive investing involves minimal intervention by the fund manager, resulting in a diversified portfolio with lower costs and a long-term investment horizon, often delivering returns similar to the market average.

What makes Passive Funds attractive vis-a-vis Active Funds?

Cost: Most actively managed funds charge management fees ranging from 0.8% to 1.2% of Assets Under Management (AUM). In contrast, Index Funds are available at a much lower cost, typically ranging from 0.06% to 0.30% of AUM.

Returns: Actively managed funds do not guarantee superior returns, even with higher fees. Index Funds aim to provide investors with market returns while reducing the risk of underperforming the benchmark index.

No Bias Investing: Index funds follow a rule-based investment approach, eliminating human discretion and biases in decision-making.

Broad Market Exposure: These funds invest in proportions that mirror the index they track, ensuring diversification across sectors. This allows investors to capture potential returns from a broader market segment through a single index fund.

Things to Keep in Mind When Investing in Index Funds

Tracking Error (TE): TE represents the difference between the fund’s returns and the benchmark index’s returns. While index funds strive to replicate the underlying index closely, discrepancies may arise due to factors like fund expenses, cash balance, or portfolio deviations.

Alpha is not the Focus: By investing in Index Funds, investors are essentially signing up for returns that closely align with the performance of the index the fund tracks.

Conclusion

In summary, Tax Saver Index Funds offer investors an investment strategy that combines the benefits of passive investing with tax advantages, much like actively managed ELSS funds. Benefits like l lower management fees, potential market returns, reduced bias, and broad market exposure make passive index funds an attractive option for those seeking a balanced and tax-efficient investment approach.

As you consider your investment choices, keep in mind the key factors discussed here to make informed decisions that align with your financial goals.