6 Mistakes to avoid while investing in ELSS
The tax-saving season has just begun with individuals exploring options to invest that can help them get tax benefits of up to Rs 1.5 lakhs under section 80C of Income Tax Act. One of the best instruments to invest for this purpose is equity-linked saving schemes (ELSS) which have the lowest lock-in of just 3 years.
However, there are some common mistakes that are generally made by an investor seeking to invest in such instrument. In this article, we will focus on some of the mistakes to avoid while investing in ELSS.
Mistake One: Beginning late
People generally start investing in ELSS towards the end of the financial year when the time for showing investment proof comes close. We believe this is not an ideal strategy as it could not only lead to cash flow mismatch problems but also may result in high cost of investment due to unfavorable market conditions.
Further, people also tend to consider ELSS as only tax saving instrument and thus rush in for making investments at the last moment. We believe this misconception should be dealt with accordingly as ELSS is an avenue which provides access to equity markets and has the potential to generate good returns over long term which also happens to a tax efficient investment.
By opting for a Systematic Investment Plan (SIP) in an ELSS fund early in the year the investor can avoid last-minute rush and also spread the investment over the year thereby benefitting from rupee-cost averaging.
Mistake Two: New fund every financial year
Another common mistake while investing in ELSS is opting for a new fund every year. Investors many times get swayed by recent performance of a fund and invest in the top performer of the year. However, there are many disadvantages of this approach, one is that it results in a portfolio which has many funds of the same category which results in difficulty in tracking and managing the portfolio, the other issue is that the approach of selecting a fund by its recent performance is faulty and a fund can always be selected on the basis of consistent performance. They tend to change the fund in which they invest every year thinking it would add better returns to the portfolio. It always makes sense to select a fund after research and sticking to it for long time and keep investing in the same fund or maximum two ELSS funds over the years.
Mistake Three: Switching funds every three years or withdrawing
Since ELSS have a lock-in of 3 years, people think that they should redeem their investment in ELSS once it completes the lock-in period. However, this approach is not correct. ELSS is an Equity mutual fund and an ideal time horizon for equity funds is at least 5 years. Once 3 years complete of an ELSS fund, its performance should be evaluated and the decision to redeem or continue should be taken based on the same. Equities are long term investments and the compounding benefit of the returns take time to kick in, hence ELSS funds should not be treated as an investment for 3 years only. There is one strategy where withdrawing from ELSS funds after 3 years can work. Click here to know more about the same.
Mistake Four: Opting for dividend plan
Investing in ELSS should be ideally done under the growth option. Since ELSS is a long-term investment it is always beneficial to opt for growth option as it brings in additional compounding benefit. Since the dividends are not re-invested but paid out under dividend plan, the dividends are not available for compounding thereby resulting in lower returns over the long-term. There is dividend-reinvestment option available in some funds; however each dividend is locked in for 3 years making it difficult to redeem the investment at one go when required. Therefore, it is not advisable to opt for dividend reinvestment option in case of ELSS.
Mistake Five: Unclear about fund category
Asset management companies generally design their ELSS funds based on a combination of large, mid and small-cap companies. Thus, depending on the share of each of the category, the risk and return profile vary for each ELSS funds. The large cap oriented ELSS funds are safer than mid cap and small cap oriented which are more volatile. Investors should ideally understand the category in which they are investing and make an informed decision based on how much risk they can take and their horizon of investment. If an investor invests just by looking at the returns without taking into account nature of holdings in the fund, it is possible that the fund’s risk profile might not match the risk appetite. We have seen that for retail investors’ first exposure to equity market is generally through ELSS funds. These investors generally have low risk appetite and hence investing in a large-cap oriented ELSS fund is ideal for them to begin with.
Mistake Six: Selecting funds based on current performance
Investors generally tend to see the returns for one-year period and sort the funds based on returns over these periods. As we discussed earlier too, we believe such approach of selecting funds is not ideal as investors generally tend to get carried away with high returns over a short term. Sustainability & consistency of returns is more important than short term high returns. We believe an investor should focus on funds which offer consistent returns over a long term.. Let us give a simple example: A batsman scoring 100 in one match with 10 in four matches is not an ideal one but a batsman with scores of 70,35,5,47,105 would be preferred.
Lastly, we at WealthTrust prepared a quick to-do tips that an investor should look out for while investing. We recommend consider the following before making any investment decisions while planning your tax:
- Look for consistent performer rather than current performer
- Large-cap oriented ELSS funds are less volatile. Take into account your risk appetite before investing.
- Start your investments from April onwards every financial year as waiting until last quarter results in opportunity loss
- Don’t change ELSS funds every year and stick to 1-2 funds to help you accumulate wealth
Should you have any more queries in relation to ELSS, its benefits, process etc. just comment on the blog and we will be there to help you understand and take the right decision.
Until then, Happy Investing, Happy Saving!