ELSS – Tax Saving Mutual Fund – How to Invest

Podcast Duration: 05:11
Hello friends and welcome to another informative podcast by Angel One.

ELSS refers to Equity Linked Saving Scheme and ELSS mutual funds are therefore mutual funds that offer investors the proposition of earnings along with tax deductions.

Tax saving does not translate to risk-free and investors had best practice a few rules of thumb in order to mitigate risks when investing in ELSS funds because they are market linked and therefore subject to market risks. Today we will examine 8 methods to reduce your chances of getting hit by losses when investing in ELSS mutual funds.

Diversify depending on capital
Depending on the volume of capital being devoted to ELSS investments, investors can reduce risks by diversifying their investments. Some seasoned investors advise diversifying investments into multiple ELSS finds if your annual investment amount is anything above Rs 20,000 per year and others say measure it differently - framing the diversification recommendation as: diversify if your monthly investment amount is anything in excess of Rs 5,000. The main point of diversification, as some of you might already know, is to offer a safety net in case one of the investments delivers losses. The profits from the others might be able to make up for the losses.

More importantly check that the fund has diversified investments
Diversifying your own investment is not enough. ELSS funds invest in a combination of debt, that is bonds and equity, refers to stocks.

It is important that the mutual fund itself has a diversified portfolio consisting of large-cap, mid-cap and small-cap stocks. It is common for fund houses to have a lean or a preference but well-balanced funds are usually the safest bet. This is linked to the fact that large cap, small cap and mid cap stocks each have their own strengths and weaknesses. Large cap stocks are at the positive end of the risk spectrum while small cap funds stand at the opposite end. On the other hand, small cap stocks trump large cap stocks when it comes to volatility. Volatility presents the benefit of quick profits.

Additionally the ELSS mutual fund should have a good number of stocks in their portfolio. According to experts, a higher concentration of high performing stocks corresponds to a higher ability to deliver returns.

Do your research
Before investing in a mutual fund, check its track record. Has it been delivering constant returns and are the returns in line with your goals? Investors should look at anything between five to ten years worth of records to identify whether a given ELSS mutual fund is a good proposition. Hands on investors also measure an ELSS Mutual Fund's performance against benchmarks (such as Nifty 200 TRI). A learning from seasoned investors is to also look at the expense ratio of a given mutual fund - or in layman's terms... consider how much of your investment goes into managing the fund versus how much you take home.

Size matters less than track record
When investing in stocks the common advice to amateur investors is to invest in bigger companies on account of them being more likely to remain stable even in the case of a downturn. When it comes to ELSS mutual funds, the general consensus is that the size of the mutual fund is not much of a factor in its potential to deliver returns.

Match your risk appetite with that of the fund house
As mentioned in our second rule of thumb today, it is common for mutual funds to have a lean or a preference for one of the three and consequently include a higher proportion of that type of market cap stocks in their portfolio. This could also impact your potential risk or return. Be sure that you know what you're getting into.

Practice rupee-cost averaging
For the same investment of Rs 1,500 per month, lets say, the number of units you get in your chosen ELSS fund could vary from one month to the next. As a result, many investors try to bring down their overall cost by investing in sustained bite-size installments.

Don't forget about the lock-in period
Keep in mind that ELSS Mutual Funds come with a three-year-long lock-in period so ensure that you are investing capital that you will not need access to for at least three years. Moreover, some investors say that even at the end of a three-year lock-in period, sometimes it makes better sense to not withdraw one's investment. It cannot be emphasized enough that investors must be certain that the funds allocated to an ELSS mutual fund are available for a long term commitment.

Stay updated
You must keep yourself informed about policy related to tax deductions and taxation on ELSS funds. As of mid-2020 ELSS mutual funds attract about 10% tax on earnings and investment in ELSS offers a benefit of 1.5 tax deduction … that is provided you are going with the old scheme and opting for deductions. How does that fare against your other options for investment, tax deductions and tax saving? Moreover, is ELSS even relevant to you or are you going with the new taxation scheme? Do your math before investing. Comparison is key to any investment game.

Besides all these guidelines, never for a moment forget the possibility of risk in any market-linked investment. Consider your risk appetite.

Happy trading!