Equity Linked Savings Schemes, or ELSS funds, are one of the most popular tax-saving investment schemes available to investors right now. This mutual fund scheme allows you to save taxes under Section 80C of the ITA, 1961, while you reap the benefits of investing in low, middle, or large-cap stocks.
However, you must choose the ELSS funds carefully to get the most out of your investments. This article will show you five things you need to consider before choosing ELSS funds. Let’s dive in.
Asset Composition of the ELSS Funds
Most fund managers allocate at least 80% of the assets of the ELSS funds to equity or equity-related investment options. The remaining assets are usually allocated to the money market or fixed income-based securities. Fund managers often choose the stocks they want to invest in depending on the objective of the fund.
For example, if the goal of the ELSS mutual funds is to maximize the returns on the investments, the fund manager may invest a significant portion of the fund in small-cap stocks. Small-cap stocks may provide higher short-term returns, but they are risky.
On the other hand, fund managers of medium-risk mutual funds invest more in large-cap stocks. Although investing in these medium-risk ELSS schemes will generate a lower average rate of return on investments, your investment will grow steadily over a long period.
The Lock-in Period
Most investment options that offer some sort of tax benefit under Section 80C of the Income Tax Act, 1961, come with a mandatory lock-in period. During the lock-in period, you cannot withdraw your invested funds. However, different investment options come with different lock-in periods. In the case of the ELSS funds, the lock-in period is just three years, which is much lower than other investment options.
Let us give you some perspective. The PPF, or Public Provident Fund, scheme has a lock-in period of 15 years. Even the NSC investment scheme has a 5-year lock-in period. Compared to them, ELSS has a pretty short lock-in period. It also has the potential to generate market-linked returns, making it a great investment option.
Invest in the ELSS Funds Through a SIP
Investors who want to invest in mutual funds have two options: lump sum investment and SIP. A SIP, or Systematic Investment Plan allows you to invest a small amount of money in a mutual fund scheme at regular intervals. It makes SIP a good way of investing in ELSS mutual funds, especially if the markets are falling.
With SIP, you can slowly invest in more mutual fund units over time to reduce the average purchase cost per unit when markets fall. This way, you won’t have to risk investing a large portion of your funds when the markets are at their peak.
What’s more, in ELSS, the lock-in period applies to every individual purchase or investment. Therefore, if you go for a SIP with a monthly frequency, every single month’s investments will have an individual lock-in period. Thanks to this, you will have greater leeway to use your money in the ELSS funds.
Don’t Add Too Many ELSS Funds to Your Investment Portfolio.
Should you invest in just one ELSS fund or more than one? When most people want to invest in tax-saving options like ELSS, they usually only care about the tax-saving aspect. And they mostly ignore the kind of effect such choices would have on their investment portfolio.
So, they just concentrate on grabbing units of a new investment option from different AMCs (Asset Management Companies) each year. Some of these investors are so focused on the tax-saving factor that they don’t even seem to care about the risk levels of the schemes. Because of this, many investors have multiple ELSS schemes in their investment portfolio after just a few years.
Now, if you don’t plan your investments carefully, you might end up investing in many ELSS schemes in just one category. This will create overexposure. Therefore, don’t just focus on the tax-saving aspect and invest in multiple ELSS schemes in the same category. Instead, research every mutual fund scheme carefully and invest in different types of ELSS funds to create a diversified investment portfolio.
The Risk Level
As we have mentioned before, the majority of the assets of ELSS funds are made up of equity and equity-related asset classes. As a result, the risk level of these funds is comparable to the type of stocks in which the fund manager has invested. But it doesn’t mean every single ELSS mutual fund is a high-risk investment option.
Fund managers handle a variety of ELSS funds that have different risk levels. And investors can choose to invest in these funds, depending on their risk appetites.
Remember, high-risk funds also have the potential to generate higher average yearly return rates. On the other hand, funds with a moderate risk level have way lower average yearly return rates compared to funds with high-risk levels.
Weigh the different investment options and your risk appetite carefully to make a solid investment plan. Ideally, your investment portfolio should have multiple ELSS funds with different risk levels, and you should divide a portion of your assets among them according to your financial goals.
ELSS schemes are one of the best long-term investment options if you want to expose yourself to stock markets while saving taxes on your investments. And there are tons of ELSS funds to invest in. However, before you choose an ELSS fund, you must do thorough research about the asset composition of the mutual fund scheme.
Take a look at the track record of the funds and inspect their risk levels. Invest in different types of ELSS funds to avoid overexposure, and choose SIP options to minimize the risk of sudden stock market crashes.
Consider all of these factors carefully for the appropriate ELSS schemes. Do you still have doubts? Contact our experts at Piramal Finance to learn more about the ELSS funds. Do you need immediate financial assistance to break through your financial bottleneck? Learn more about our personal loan programs.