ELSS Fund Guide: Mistakes to avoid while investing in tax saving mutual funds

Karan Batra, Chief Product Officer, MarketsMojo

Don’t invest only to save tax on your investment. Like in all fund categories, there are various funds with varying degrees of track record, investment style, etc. Choose the ELSS fund that has displayed consistent performance and has a strong portfolio, tax savings are an added advantage.

Gautam Kalia, SVP & Head Super Investor at Sharekhan by BNP Paribas

ELSS is not only for Tax Savings. You are investing in an Equity Mutual Fund. The aim of these funds is capital appreciation over the long term and hence these funds need to be viewed as such. If you invest only for the tax benefit you are missing the forest for the trees. Most scramble at the last minute to invest in ELSS for tax saving. SIP in ELSS is also a good option as it gives you the benefit of value averaging (as most SIPs do).

Mr. Arun Kumar, VP and Head of Research, FundsIndia

Usually a lot of us sort the funds based on their 3 year and 5 year returns and tend to pick funds with the highest returns. This approach of selecting funds only based on their past returns usually doesn’t work well in the long run.

This is because Equity funds go through cycles. Different investment styles, market cap segments, sectors, and geographies perform well at different times. Due to this, basing the selection of funds solely on returns does not work well over long periods of time. While past performance is a useful metric to evaluate a fund, it can never be the only one.

Ideally, you should look at a number of quantitative and qualitative factors to derive conviction on the future potential of a fund such as:

1. Consistency in the underlying investment strategy and philosophy over time.

2. Consistency in performance across long periods of time (percentage of times the fund outperformed the benchmark on a 5Y and 3Y Rolling Return basis over the last 10-15 years)

3. Performance track record over market cycles

4. Risk – Maximum Drawdown, Downside Capture Ratio, Extent of declines during bear markets etc

5. Concentration Risk

6. Portfolio Turnover

7. Possible Size Constraints (if the fund size becomes large)

8. Fund Manager Track Record & Experience

9. Fund Manager Communication

10. AMC pedigree

11. Expense Ratios

Ajay Agarwal, Associate partner, Alpha capital

Equity Linked Savings Scheme (ELSS) is a type of mutual fund scheme that invests primarily in equities and offers tax benefits to investors under section 80C of the Income Tax Act. While ELSS can be a good investment option for those looking to save tax and earn good returns over the long term, it is important to avoid the following mistakes:

Risks: An investor needs to understand that ELSS ultimately invests his/her money in Equities. Equity ultimately is a risky asset class, which can be volatile in the short term. It is important to understand the risks associated while investing in equities and be prepared to hold on to your investment for a longer term to reap its benefits. Investors who are risk averse or very senior citizens should opt for other stable options like PPF.

Diversification: 80c investment needs to be done every year. Not diversifying your portfolio and investing into the same ELSS scheme every year could lead to concentration risk. It is important to diversify and invest into different ELSS schemes. One can even opt for multiple ELSS schemes in a single financial year

Timing The Market: Timing the entry and exit in the market can be a big mistake. Instead it is important to have a disciplined approach and stay invested for the long term. We suggest putting in SIP rather than doing a bulk investment at the last moment in the month of march.

Monitoring: Investors typically do not bother monitoring investments with lockin. While ELSS is a long term investment, it is important to monitor it on a regular basis.

Expense Ratio: Expenses can impact your returns over long term. It is important to consider the expense ratio while choosing an ELSS scheme for yourself

Overall it is important to do your research and understand the risks associated while investing in ELSS. Seeking advice for a financial planner can be helpful.

Ishkaran Chaabra, founding partner- Centricity Wealth

Under the Mutual Fund investment category, the Equity-Linked Savings Scheme (ELSS) is a popular tax-saving investment option. However, not all investors are aware of the drawbacks of investing in ELSS incorrectly or haphazardly.

These are the common mistakes while investing in ELSS-

Investing for the Sake of Reducing Tax.

Do extensive research and invest in funds that are performing well to enjoy better long-term returns. If you don’t want to take too much risk, consider investing in large cap funds. Also, invest early and stay active in your investment journey to become well-versed in the market while outperforming inflation.

Last Minute Lump Sum Investment at the End of The Financial Year

Investing in ELSS funds in a lump sum can be a mistake. Because ELSS are equity investments, the market conditions at the time of your lump sum investment will have a significant impact on your returns. Instead, consider lowering your overall risk by making smaller investments throughout the fiscal year.

Waiting for the Best Time to Invest in the Market.

Nobody can forecast the market. Any seasoned investor will tell you that they have witnessed the highest of highs and the lowest of lows. To be on the safe side, do some research and invest in the top-performing funds, especially if you’re a first-time investor. Invest actively to become acquainted with the market.

Choosing the scheme based on the current performance.

Because ELSS funds are appropriate for long-term investment goals, a fund’s performance cannot be judged by its current 5-star rating. While there is no harm in selecting such a fund, the best way to be safe is to evaluate the fund’s track record, where its assets are invested, the process behind its consistently good performance, and so on.

Neglecting the Fund Category.

It is critical to choose a fund category before investing in it. Asset management firms provide ELSS mutual funds in three categories: small, mid, and large-cap funds. The funds you choose are determined by the amount of risk you are willing to take on with your investment.

Finally, your ELSS is about more than just lowering your tax burden. It must also meet two additional criteria: your risk tolerance and financial plan. Invest wisely and with discretion in ELSS to maximise your tax savings while also yielding a higher return on your investment.

Divam Sharma, Founder at Green Portfolio, SEBI Registered Portfolio Management Service Provider

ELSS is an effective way to save taxes by investing in high growth equities assets. Also, considering that there is a 3 years lock-in, this product offers investors to make more returns from a longer term commitment.

1. Investors should always stagger their investments in equities. This should be done throughout the year in an SIP mode and not in an lumpsum mode at the end of the year.

2. Redeeming ELSS right after lock-in might impact the returns on the investments. The exit should be planned also considering overall market conditions, as market cycles, in times of volatile markets, can result in short term drawdown on your investments and if you defer your exit in such times, your actual returns can be substantially higher.

3. If you are allocating money to equities, the compounding benefits come when the money stays invested for a longer period. If you opt for IDCW option, the reinvestment benefits are not received as well as your payouts are taxed at your tax slabs.

4. Over diversifying at multiple ELSS schemes should be avoided

5. Historical returns should not be the only criteria to choose your ELSS, you should evaluate many other criteria’s like the category, investment philosophy, AMC, Fund Manager profile, expense ratio, sharpe ratio before investing.

6. Investors should not invest in ELSS with the sole motive to save tax. They should understand different asset classes, risk associated with ELSS investments, lock-in, returns etc before investing.

The views and recommendations made above are those of individual analysts or broking companies, and not of Mint.

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