The act of investing comes with a lot of risks. If you are seriously considering investments as a possible avenue for earning an extra income you need to be prepared to take risks. Please remember, the higher the risks, the higher the rewards (if the asset you invested in performs well). To invest, first of all, you need an investment plan. One of these plans is ELSS funds, which is a subcategory of mutual funds.
An equity-linked saving scheme (ELSS) is an open-ended equity mutual fund which is known for investing primarily in equities and equity-related products. ELSS funds are a special category among mutual funds that qualify for tax deductions under Section 80C of the Indian Income Tax Act, 1961. Thanks to this aspect, they are popularly known as tax saving mutual funds. These funds are known to provide investors with the opportunity to earn reasonable returns and save on tax. They invest at least 80% of the scheme’s assets such as equities. So, it is important to remember that the returns you could earn on them are directly linked to the stock market’s performance. This can be a suitable option if you want to invest for long-term goals such as creating a retirement corpus or buying a new house.
Are there any tips while investing in ELSS?
While investing in these funds, investors commit numerous mistakes. Listed below are some of the common mistakes that you need to avoid while allocating funds into ELSS:
- Binding yourself to the Section 80C limit:
Your decision to invest in ELSS should not be driven purely by the Section 80C benefits. Once you start moving up the income ladder, Section 80C will become increasingly inadequate. Apart from tax saving, you can look at the ELSS as a long-term wealth-creating instrument too. Its 3-year lock-in period will instil the long-term discipline in you. Apart from instilling discipline, the fund manager will have the incentive to act in a more long-term manner considering the lock-in period. Please remember that these funds are a great investment option even on a standalone basis. Therefore, you should not restrict yourself by the limits of Section 80C. You can look at ELSS even outside of that.
- Including too many ELSS funds in your portfolio:
Holding too many ELSS funds in a single portfolio is a common mistake a lot of investors commit. Every year, they tend to select the ELSS issued by a different AMC and over a few years, they end up with a portfolio of ELSS funds that is spread across 7-8 AMCs. When you invest in an ELSS fund or any fund for that matter, it is of utmost importance that you constantly track it. That means, you need to track the performance, benchmark with the indices and you check the portfolio holdings of the ELSS, and you need to ensure that the expense ratio is under control. It is humanly possible to closely track the portfolio of just 1-2 ELSS funds. If you were to hold 7-8 ELSS funds and you do not have the time to track these funds, then the entire purpose gets defeated.
- There is no necessity to exit after 3 years:
One of the popular reasons that many investors prefer ELSS funds is that their lock-in period is the lowest at just 3 years. In contrast, other assets like PPF and long-term deposits have lock-in periods of more than 5 years. However, the common mistake of many investors is that they redeem their ELSS funds the moment the 3-year lock-in period is completed. Please remember that the 3-year lock-in period is just for your tax break. Actually, you can hold on to the ELSS fund as long as you want. For instance, ELSS has an advantage over diversified equity funds in the sense that fund managers can take a longer-term perspective due to the 3-year compulsory lock-in. This helps in generating returns in the long run. So, if you are invested in an ELSS fund and are sitting on healthy profits at the end of 3 years, there is no reason for you to redeem your investment. You can treat it just like any equity fund and hold on as long as it creates wealth.
- Not keeping your risk appetite and financial plan in mind:
While opting for an ELSS fund you must never lose your sense of perspective. Apart from reducing your tax burden, it has to fit two more conditions. Firstly, it must fit your risk appetite. If you are someone over the age of 50, don’t just keep adding more ELSS to your portfolio. Likewise, you need to ensure that your ELSS fits into your overall financial plan that lays out your ideal equity and debt allocation plan. If this is not taken care of then you may end up investing in an ELSS and saving tax, but it may be at cross purposes with your overall financial plan.
- Ignoring the merits of a SIP approach:
A SIP or systematic investment plan is a method in which money is debited from your account regularly. Through this approach, you will enjoy the benefit of rupee cost averaging, especially in volatile markets. Apart from that, there is one more advantage. The ELSS lock-in starts from the date of investment. In the case of a SIP on an ELSS, the lock-in period will begin exactly from the month of investment. That gives you a 1-year advantage in making your ELSS fund more liquid.
Please remember that an equity-linked saving scheme is a great instrument to get the benefit of tax saving and wealth creation. By taking care of these common mistakes, you can make the most of your ELSS.
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.