Earning money is tough. Whether you are an employee or a self-employed individual, you know money doesn’t flow in without the hustle. And to pay almost 30% of what you make to the government can be very painful. But what if there was a way to avoid it completely or lower the percentage of the total taxes you pay?
Well, there are multiple ways to do that. In today’s blog, let’s discuss one such way. Let’s understand the Equity Linked Savings Scheme in-depth and how you can choose the best-performing ELSS.
What is an ELSS?
Equity Linked Savings Scheme (ELSS) is a mutual fund scheme that invests in equities and qualifies for tax deductions under Section 80C of the Indian Income Tax Act, 1961. By investing in an ELSS, you can claim a tax deduction of up to Rs. 1.5 lakh per year from your taxable income under section 80(C) but only if opt for the old tax regime.
ELSS stands out as one of the top investment choices due to its potential for higher returns compared to traditional fixed-return tax-saving instruments. It has the shortest lock-in period among the Section 80C options, requiring you to hold your investment for three years before you can redeem or withdraw it.
How to choose the right ELSS fund for your portfolio?
ELSS funds provide opportunities for long-term growth along with tax benefits. Just like other mutual fund categories nd stocks, there is a wide variety of ELSS funds to choose from.
A three-year lock-in period makes ELSS ideal for investors with a long-term investment horizon who don’t require immediate liquidity and want to lower their tax burden.
Investment strategy of ELSS funds
As the name suggests, ELSS funds use equity exposure to earn returns. Some focus on large-cap stocks, which offer stability and are suitable for risk-averse investors.
While other funds may focus on investing in mid and small-cap stocks to get growth which comes at a higher risk.
However, in most cases, ELSS funds function like flexi-cap funds. It means they invest across companies regardless of the market capitalisation.
The three-year lock-in period provides fund managers with the flexibility to take higher exposure to mid and small-cap stocks. Many fund managers have the flexibility to generate higher alpha for investors, given that there is a lock-in period of 3 years. It is also noteworthy that this three-year lock-in period is the least among all the tax-saving schemes available.
Before you invest in an ELSS fund, make sure it aligns with your risk tolerance and investment timeline.
Performance of ELSS funds
The past performance of an Equity Linked Savings Scheme must be gauged to look at its track record. Consistency is a key indicator of a sound investment strategy.
When selecting an Equity Linked Savings Scheme, choose the fund that has consistently delivered returns across various market conditions. Avoid funds with extreme performance fluctuations, as it may not be ideal for long-term wealth generation.
Instead, opt for funds that have shown the ability to provide stable returns over time.
You can check the consistency of returns with the rolling returns earned by the fund. Unlike trailing period returns, which can be heavily influenced by recent performance, rolling returns provide a more balanced view of average performance over different market cycles.
Understanding key metrics
There are various methods to evaluate a fund’s performance like ratios and certain qualitative factors. Let’s explore some of these metrics to better understand how to assess an ELSS fund’s performance.
Sharpe ratio
The Sharpe ratio measures a fund’s risk-adjusted returns. A higher Sharpe ratio indicates that the fund generates better returns for the level of risk taken.
Standard deviation
Standard deviation reflects the volatility or fluctuation in a fund’s returns. A lower standard deviation suggests lower volatility, making the fund more suitable for risk-averse investors seeking stability.
Fund Manager’s expertise
The expertise of the fund manager is essential to understand the performance of an ELSS mutual fund. Investors should consider the fund manager’s experience and track record in managing equity funds.
Investment style
The investment style reflects the characteristics of the underlying stocks selected by the fund manager.
A growth-oriented fund invests in companies expected to deliver faster earnings growth than the market. These stocks have a higher Price to Earnings (P/E) ratio.
A value-oriented fund focuses on undervalued stocks expected to gain market recognition, usually holding stocks with lower P/E ratios.
A blend fund combines both growth and value stocks. Diversifying your portfolio with a mix of growth and value funds is generally advisable.
Is SIP in ELSS fund a good idea?
Investing in ELSS through SIP involves making periodic instalments on predetermined dates. This approach helps to build investment discipline, which is a major benefit. With SIP, you may end up buying more units when the market is down and fewer units when the market is up. This averages out the purchase price over time.
Each ELSS SIP instalment is locked for three years. For instance, if you started an ELSS SIP in January 2020, the units allotted in January 2020 would be locked until January 2023. Subsequent instalments in February and March would be locked until February 2023 and March 2023, respectively.
Investing through the lump sum method calls for prior tax planning and doesn’t require you to lock in your funds for a prolonged period.
Hence, it’s advisable to opt for a lump sum investment as it helps you plan your taxes and doesn’t lock in your funds for a prolonged period. Since the returns are not averaged out, it’s recommended to invest when the markets are not at its peak.
As the Income tax filing season approaches near, you are equipped with the knowledge to select the right ELSS fund to save on taxes and build wealth. If you haven’t done your tax planning for the year yet, you can consult Geojit Financial Services to help you plan them. Geojit is your one stop solution to all your financial needs.
