5 Things to know about ELSS Funds
Equity Linked Saving Scheme (ELSS) is the best tax saving investment available to you. Under ELSS, you invest in a mutual fund with a 3-year lock-in. A well-researched choice of ELSS assures not only, higher returns associated with mutual funds but also, allows you to reduce taxable income for that year. This might seem straightforward but there are some things that need to be kept in mind to ensure you choose the right ELSS fund among available ELSS funds.
You will learn-
- How much to invest in ELSS?
- When to invest in ELSS?
- When will I get the invested amount back?
- Common misconceptions about ELSS funds
- Dividend vs Growth ELSS mutual funds
- Last year’s best performing fund
- Buying multiple ELSS schemes
- ELSS and Senior Citizens
- Should I invest in the ELSS fund my friend is invested in?
- What are the different ways to check an ELSS fund performance
- Our Recommended Approach
Let us look at them in detail one by one-
1. How much to invest in ELSS?
Let us say, you will be saving Rs 3 lakhs this year. You want to invest them for higher returns in mutual funds. You have made contribution of Rs 40,000 in other 80C instruments like Public Provident Fund (PPF) & Employee Provident Fund (EPF). Then, the correct amount to invest in ELSS mutual fund will be 1.1 lakhs for the year. The rest of 1.9 lakhs should be invested in an equity mutual fund without the 3-year lock-in. The upper limit of exemption under 80C is 1.5 lakhs.
2. When to invest in ELSS?
ELSS fund like any mutual fund will move up and down throughout the year. Putting a lumpsum in one go can lead to suboptimal results by entering at a time when market is expensive. A monthly SIP is recommended to get the benefits of cost averaging as well as to avoid too much hassle of investing every week in weekly SIP. Check out our research that shows monthly SIP in ELSS leads to higher returns.
3. When will I get back the invested amount back?
Redemption happens in ELSS funds on “first in first out” If you deposit a monthly installment on April 1, 2017, then you can redeem it on April 1, 2020. Similar redemption cycle will be followed for other months’ installment.
4. Common misconceptions about ELSS funds
- Dividend vs Growth ELSS mutual funds- Unless you really need regular income never invest in dividend ELSS mutual fund. Dividends in mutual funds are given to you from your profits only. This means lesser amount is compounded and lower rate of return than Growth ELSS mutual fund. Also, in ELSS if you choose dividend reinvestment option then each dividend is locked in for 3 years from the dividend declaration date.
- Last year’s best performing fund- You might be tempted to go for the last year’s best performing fund. We might do this because choosing a mutual fund can be complex and we take a mental shortcut this way. However, this will be a suboptimal decision. There are many factors that you should look for while choosing a fund, like consistency, ratios etc. We will explain this later in this article.
- Buying multiple ELSS schemes- You might be tempted to diversify across two or three of the best mutual funds. This might be because all seem to be equally good. However, this leads to confusion when looking at returns and managing them can be cumbersome. There is no need to diversify across mutual funds since each mutual fund in itself is diversified and holds a sufficient number of stocks. Also, do not buy a new ELSS fund each year; better option is to invest through SIP in the same fund.
- ELSS and Senior Citizens- The most popular investment instrument for Senior Citizens is Senior Citizen Saving Scheme. However, SCSS not only has lower returns but also capital gains from it are taxable. If you are senior citizen with taxable income then you should go for ELSS. If you do not have a taxable income then too you should go for mutual funds. You may read more about it here.
5. Should I invest in the ELSS fund my friend is invested in?
No, you shouldn’t invest in an ELSS fund just because your friend is already invested in it or is recommending it. We might find ourselves in this situation because we need to file taxes and don’t have enough time to do our own research. For that matter, even your tax consultant’s recommendation will not be reliable because his job is to help you save tax but not make returns. You should either do your own research or depend on a wealth advisor for the same. Remember ELSS is an investment for at least 3 years (though ideal horizon for any equity investment is 5 years); you don’t want to have suboptimal returns. We will now share with you how to choose an ELSS.
- What are the different ways to check an ELSS fund performance?
Risk profile- The stocks are classified into large caps, midcaps or small cap. Large caps are less risky than midcaps and midcaps are less risky than small caps. Similarly, an ELSS fund can have majority of its stocks from any one of these. So, ask yourself how much risk are you willing to take. The potential upside potential is generally higher for midcaps and small caps.
Direct vs Regular- You should never invest in regular mutual funds because extra 1-1.5% as commissions is deducted from the NAV of a regular plan. This may cause your returns to be lower by 30%-40% in long term. You may check more about Direct vs Regular plans here.
Return beating the benchmark and category- Fund managers take professional fees for managing money on your behalf. The first thing to look at whether the fund has produced returns that beat the benchmark and category average for the corresponding period.
Consistency- Most ELSS funds are older than 5 years. We would advise you to compare the returns for 3-year, 5-year and since inception for consistency. Also check if the fund has beaten the benchmark and category average year on year most times in past 5-10 years. A fund manager talent is shown in being able to manage consistent returns in all periods.
Upside Capture Ratio and Downside Capture Ratio- An upside capture ratio > 100 means that mutual fund gains more than benchmark when the market is going up. A downside capture ratio < 100 means that mutual fund loses less when the market goes down. Both are indicators of fund managers’ superior ability.
Sharpe Ratio- Sharpe ratio > 1 indicates a higher risk adjusted return delivered by the fund. Funds with Sharpe ratio < 1 should generally be avoided. A higher Sharpe ratio is again an indicator of fund’s superior performance.
Fund Philosophy- Fund managers share the objective of the fund and how they are going to achieved it. You can read it to understand the fund philosophy. However, this might not be the only reason you invest in a fund.
- Our Recommended Approach –
You should opt for a direct mutual fund. Choose an ELSS fund which invests in Large cap, Mid Cap or Small cap according to your risk tolerance. We recommend consistency over chasing the highest returns, since the inconsistent ones tend to underperform after their best performance. Within the shortlisted options, go for the fund with better upside capture ratio, downside capture ratio and Sharpe ratio.
We at WealthTrust, specialize in direct mutual funds advisory. We have investment experts monitoring funds on all these parameters. We help you arrive at your goals and risk profile to recommend the plans personalized to you.