Why Tax-Savers Should Consider Investing in ELSS

For tax-saving purpose, there a galore of traditional investment options available: Public Provident Fund (PPF); National Savings Certificate (NSC); 5-Year Tax Saver Bank Fixed Deposit; etc., among others.

Investments in tax-saving avenues entitle you for deduction up to Rs 1.5 lakh per annum under Section 80C of the Income-Tax Act, 1961.

However, when you are adding traditional investment instruments to your tax-saving portfolio, it is important that you pay attention to your risk profile and complement tax planning with investment planning.

Doing this will help you make suitable investment choices in the endeavour to create wealth and achieve the envisioned financial goals.   

If you are risk taker, generally your focus should be on picking investment avenues offering market-linked returns. A risk-taker can be classified as someone who is young (in the accumulation phase of life cycle); in the high-income bracket; owns considerable assets; has limited liabilities; whose time horizon before financial goals befall is far; and/or in general who is willing to take high risk (aggressive).

Among the market-linked instruments, Equity Linked Savings Scheme (ELSS)––also known as a tax-saving mutual fund––is one of the good avenue for tax-saving.

ELSS is one of the sub-categories among the diversified equity funds, which offers the dual advantage of wealth-building potential and tax-saving benefit under Section 80C.

As per SEBI’s categorisation norms for mutual funds, ELSS is an open-ended equity-oriented mutual fund scheme that invests a minimum 80% of its assets in equity & equity related instruments (in accordance with Equity Linked Saving Scheme, 2005 notified by Ministry of Finance).

A distinctive feature about ELSS is that unlike other open-ended diversified equity mutual funds, investment in ELSS is subject to a compulsory lock-in period of three years. During this period, the investor, cannot redeem your investments.

What is the investment objective of an ELSS?

The broader investment objective of an ELSS is a long-term capital appreciation by investing primarily in equity and equity-related instruments.

How to choose the right ELSS?

Since investing in an ELSS is quite similar to investing in any diversified equity fund. What sets ELSS different from these funds is only the fact that investment in ELSS help save tax under section 80 C and the fact that it has a lock in period. The below factors could be evaluated when investing in an ELSS fund based on a host of quantitative as well as qualitative parameters:

• Returns over various time frames (especially over 3-year, 5-year, 10-year, since inception periods)

• Performance across market phases (i.e. bull and bear phases)

• Risk ratios (Standard Deviation, Sharpe, Sortino, etc.)

• The expense ratio of the scheme

• Portfolio characteristics (the top-10 holdings, top-5 sector exposure, how concentrated/diversified is the portfolio, the market capitalisation bias, the style of investing followed – value, growth, or blend, the portfolio turnover)

• The credentials of the fund management team (the experience of the fund manager, the number of schemes he/she manages, the track record of the mutual fund schemes under his/her watch, the experience of the research team)

• And the overall efficiency of the mutual fund house in managing investors’ hard-earned money (i.e. the proportion of AUM actually performing)

In addition, understanding the investment philosophy, processes and systems at the mutual fund house is useful.

Do not base your investment decisions merely looking at past returns because it not necessarily indicative of future returns.

Also remember, the best-performing ELSS fund of one period may not necessarily be the best ELSS fund for the next period; the performance may vary (depending on the undercurrents in force). That’s why a holistic approach is essential to select the best ELSS fund among the plethora of choices available so that it potentially proves to be a rewarding experience in the long run.

For how long should one stay invested in an ELSS?

Considering the minimum time horizon for your investments in ELSS is 3 years, your investment time horizons could be at least 3 to 5 years. Avoid getting perturbed with short-term underperformance or volatility. It is important to give your investment in ELSS sufficient time to grow and generate meaningful risk-adjusted returns. The lock-in period thus ensure you are invested for a considerable long-term time frame.

What is the minimum and maximum investment limit to invest in ELSS?

The minimum investment amount for most ELSS is as little as Rs.500, with no upper limit.

However, do remember, only a sum up to Rs 1.50 lakh per annum (in the year you invest) is eligible for deduction under Section 80C of the Income Tax Act, 1961.

One can invest a lump sum and not worry about the tax saving under sec 80C with investment with potential of generating wealth for long term. However, come the month of January – February and tax-savers usually face the insufficiency of resources. These investors could also opt for Systematic Investment Plan (SIP) in ELSS.   

SIP in ELSS funds helps tax-savers to not just save enough tax in a phased manner but also make the most of compounding effect.   

In the case of SIP in ELSS investors need to know that, every SIP instalment in ELSS will be subject to a lock-in period of 3 years.

To sum-up…

ELSS is a good investment avenue to save tax, provided a judicious approach is followed.

Remember, every Rupee legitimately and wisely saved from tax is a Rupee earned.

Happy Tax Planning & Investing!

Guest Post from Quantum Asset Management Company