It is imperative to plan your taxes before beginning your investment journey. Some provisions under the Income Tax Act 1961 enable you to save tax. Numerous tax-saving instruments might help you complement tax planning with investment planning under the provisions of the 1961 Act. One of these financial instruments is a tax-saving mutual fund or equity-linked savings scheme or ELSS.
What is an equity-linked savings scheme?
ELSS investments allocate funds to equity and equity-oriented securities. After investing in equities, the fund manager managing your portfolio invests a portion of the corpus in debt securities. Section 80C of the Income Tax Act 1961 applies to an ELSS mutual fund. You can claim tax deductions of up to ₹1,50,000 annually under the provisions of the 1961 Act. This provision can help you save approximately ₹46,800 every year in taxes. Furthermore, these equity schemes have a lock-in period of three years, which is the shortest among all 80C options.
However, there are some tips that you must keep in mind before investing in an ELSS fund. Once you have determined your investment amount by using a mutual fund calculator, keep these six tips in your mind:
- Remember the lock-in period
First, you must remember that ELSS funds are known for coming with a lock-in period of 3 years. Three years is considered the shortest lock-in period among other tax-saving investment options under Section 80C. Also, these funds come with the potential of earning higher returns in comparison to other tax-saving options. ELSS funds can help you save tax up to ₹46,800.
- Consider the past performance
Before investing in your ELSS, please check the fund’s performance over time and different market cycles. Assess the consistency with which the ELSS performed and how it fared against its benchmark index. However, it is imperative to note that no ELSS can be a top performer year after year.
- Assess the risk-adjusted returns
Assess the risk associated with the fund to choose a suitable ELSS fund. You can assess the risk by observing the standard deviation. A higher standard deviation denotes that the scheme is volatile or risky compared to the benchmark. A lower standard deviation demonstrates that the ELSS can adequately compensate its investors for the risk taken.
- Study the portfolio characteristics
ELSS performance relies heavily on the performance of the underlying stocks or other equity-related instruments. Therefore, it is vital to assess the portfolio characteristics. This includes analysing the market capitalisation, the sectors it has exposure to, the fund management style, and top-10 holdings.
- Consider the fund manager’s credentials
The fund manager is responsible for taking care of your mutual fund portfolio. Your mutual fund portfolio’s NAV depends on the fund manager’s ability. You must also must evaluate the track record of the other schemes managed by the manager. Most importantly, a fund manager should not be overseeing more than 5 schemes at a time. When a fund manager is overburdened, inefficiency is likely to kick in.
- Check AMC’s reputation
Apart from checking the fund manager’s credentials, you must also look up the asset management company (AMC)’s reputation. Check the ideology or philosophy of the AMC, its experience in managing a particular asset class, and the investment process.
These six tips will help you make the most of your ELSS fund. Contact a financial advisor as soon as possible if you have any doubts.
