Of tax-saving investments: here’s how to pick the right ELSS fund

ELSS funds come with a mandatory three-year lock-in period.
ELSS funds come with a mandatory three-year lock-in period.

Summary

  • ELSS have gained popularity for their dual benefit of tax savings and potential wealth creation through equity investments.

Tax-saving investments are an essential part of financial planning, and equity linked saving schemes (ELSS) have gained popularity for their dual benefit of tax savings and potential wealth creation through equity investments. However, picking the right ELSS fund is not that straightforward, given wide range of options available, across different fund houses.

Here is a checklist that can help to choose a suitable ELSS fund.

Fund performance: Look for a fund with a solid long-term track record across various market cycles. Consistent performance is a good indicator of the fund’s reliability. Avoid selecting funds based on short-term performance. Look for three-, five-, seven- and 10-year period returns. A fund which has performed well over all periods would indicate consistent performance.

Investment framework: Opt for a fund that has a well-defined investment framework.

Passive funds: With passive equity funds outperforming active funds in the last few years, there is a strong argument to invest in passively managed funds. You may opt for passive schemes which track indices like Nifty 50 or Nifty LargeMidcap 250 Index. There are fund houses that have now started offering passive ELSS options.

Check expense ratios: High expense ratios can eat into your returns. Compare the expense ratios of different ELSS funds to choose a cost-efficient option.

Market cycles: Avoid selecting funds based on short-term performance. Fund managers may have different styles (like growth, value) and a style that has worked recently may not work in the future. Also, if the fund is managed with an aggressive investing style, it may not suit some investors’ risk-profile, while a conservatively-managed fund would be more suitable for some investors.

Diversify: If you already invest in equity mutual funds other than ELSS, you may want to diversify for your ELSS investments. You can opt for a different fund house or a different style of investing for your ELSS.

Systematic investment plans (SIPs) or lumpsum?

ELSS funds are typically marketed near the end of the year as tax-saving instruments. Choosing between SIP and lumpsum depends on your risk-tolerance. SIPs provide a disciplined approach which helps to reduce the risk as SIPs are spread over a period rather than a particular date.

Stay or exit after lock-in?

ELSS funds come with a mandatory three-year lock-in period. While some investors exit after the lock-in period for liquidity, staying invested can harness the power of equity compounding.

The ‘time in the market’ is more important than ‘timing the market’. The ‘time in the market’ aspect is taken care by the three-year lock-in to some extent. One can exit the fund if it is underperforming significantly compared to the broader indices. The proceeds may be reinvested in non-ELSS schemes with better potential.

ELSS versus other tax-saving avenues

ELSS is a pure equity product. So, it is bound to go through volatile phases. Risk-averse investors might prefer the stability of Public Provident Fund (PPF), Sukanya Samriddhi scheme, National Savings certificate, etc. If the Section 80C limit ( 1.5 lakh) of the investor is filled up by avenues like the ones mentioned above or other avenues like insurance schemes, home loan principal payments, etc, then the investor need not invest in ELSS schemes. The tax treatment on the returns of ELSS funds are the same as other equity funds, so there is no incremental tax-benefit on its returns.

Keeping tabs

Contrary to common practice, ELSS funds require regular monitoring. Even if you may not redeem your investments in ELSS funds, you may opt to invest in a different funds for future investments.

In conclusion, pick the ELSS fund as per your objectives, risk-tolerance and horizon to hold the investments for at least three years.

Vijay Kuppa is the chief executive officer of InCred Money.

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