All you need to know while investing in ELSS Funds

“…but in this world nothing can be said to be certain, except death and taxes.”

– Benjamin Franklin

Most of the investors who have to make tax-saving investments can relate to this, as we approach the end of the financial year.  With multiple options available to make the tax-saving investments; we thought we will make it easy for you by creating a comprehensive guide for ELSS funds.

Let’s start with Section 80C.

Under Section 80C, you can claim the tax benefit of up to 1,50,000. In other words, your taxable income will reduce by 1,50,000 if you invest under section 80C. Now, you can take this benefit with the help of multiple financial investments. Some of the commonly used instruments to save tax are :

Now, amongst all these investment options, Why should you choose ELSS over other options to complete your limit of investment in section 80C?

Pros:

• Lowest lock-in period if compared to other tax-saving avenues – This gives easy liquidity in the world of uncertainty.
• Exposure to equity can boost portfolio performance.
• ELSS funds can also be used to fulfill the financial goals which are 5 or more years away.

Cons :

• The amount which can be redeemed is taxable @ 10% over the profit of 1 Lac.
• Exposure to equity can also bring some volatility in the portfolio.

Although, it is a well-established fact that equity investments can be volatile; its importance in any portfolio cannot be denied. Equities do give a much-needed boost in returns to the overall portfolio.

Now let’s look at some of the factors you can look at while investing in ELSS funds:

ELSS funds are essentially multi-cap funds with a lock-in period of 3 years. But does that mean you can just pick anyone and invest? The answer is a Big No.

Since ELSS funds act as a multi-cap fund, there is no clear mandate given to them as to how much investments should be done in Large Caps, mid-caps or small caps. Hence each fund ends up having different market capitalization exposure.

Look at the broad portfolio break up of ELSS Funds while shortlisting the funds:

Below are some of the top ELSS funds and their portfolio breakup:

These funds have higher exposure to large-cap stocks with higher average market capitalization.  Hence the volatility is lesser with consistent returns. You can select such funds if you are not willing to take high risk while making tax-saving investments.

Whereas, these funds have higher exposure in mid and small caps with lesser average market capitalization. This, in turn, implies that the volatility will be higher in these funds. If you are fine with the higher risk in your portfolio, you can opt for such funds.

Also Read: ELSS vs SIP

You do not need more than 2-3 ELSS Funds in the portfolio

We have come across many investors who invest in too many ELSS funds with the rationale of diversification. However, having 7-8 ELSS funds in the portfolio has more downsides. Tracking each fund’s performance will become a tedious task if you hold too many tax-saving funds.

Instead, the right approach would be to select 2-3 funds with different investment methodologies so that your portfolio of tax-saving funds does well across market cycles.

You should map the ELSS funds to financial goals

As we have said before, ELSS funds are multi-cap funds, so the rules of equity investments apply here too.  That means you need to hold on to these funds for at least 5 years (even though the lock-in period is 3 years) to optimize the risk-return matrix.

If you map these funds to your goals which are 5 or more years away, they can serve the dual purpose of saving your tax and fulfilling your goals.

SIP or Lumpsum: What approach is right for ELSS investments?

SIP or lumpsum completely depends on the individual’s comfort and convenience. However, if an investor waits till January for making the ELSS investments and if the market is in an upward trajectory then the entry points would become expensive. In the case of SIP, entry points are staggered across a year which allows us to enter at different price points.

SIPs can be set up at the start of the financial year so that at the end of the year we do not have to rush to accumulate the tax saving amount. However, one point to remember is that when you start a SIP in ELSS funds, each installment needs to complete a period of 3 years in order to redeem the fund. So the redemption amount will be equal to the installments which have come out of the lockin period.

This is everything you will need before deciding which ELSS to invest in. With two months still remaining for making a tax-saving investment, choose right and choose wisely.