Looking beyond tax savings: How ELSS funds can help you attain your goals?

Date : 23/06/2021
Read: 5 mins

ELSS funds often work as a tax-saving instrument but they can also be used to save money and attain your financial goals.

Looking beyond tax savings How ELSS funds can help you attain your goals

Thanks to inflation-beating returns offered by mutual funds and investor education efforts made by asset management companies as well as The Association of Mutual Funds in India (AMFI), India’s mutual fund penetration has reached 12% of the total GDP. As you might know, there are various types of mutual funds ranging from equity to debt to hybrid.

ELSS or equity linked saving scheme is a type of mutual fund that has emerged as a popular tax-saving instrument. To save taxes, investors would invest Rs 1.5 lakh (the maximum amount that can be claimed as tax benefit) as a lump sum amount in an ELSS scheme before March 31. However, ELSS funds have delivered double-digit returns to investors over the previous decade and can hence be a viable medium to achieve your financial goals.

What kind of goals can be achieved through ELSS?

ELSS funds have a lock-in period of three years. Therefore, this rules out using ELSS funds for achieving short-term goals. It is pertinent to note that ELSS funds invest at least 80% of their funds in equities or equity-related instruments. Hence, you may want to invest in ELSS to achieve medium- or long-term goals.

Medium-term goals can be achieved within 5-7 years. These may include purchasing a vehicle or taking the family on an international vacation. Long-term goals may take longer to achieve, maybe 8-10 years or more. Examples include arranging the down payment for a house or creating a corpus for retirement.

Why is ELSS a great medium for achieving financial goals?

Lock-in period creates discipline: Unlike other modes of investment, one can watch the current valuation of one’s investment in the stock market on a daily basis. The volatility of the stock market may force novice investors to take rash decisions and ignore the benefit of long-term investing. ELSS inculcates discipline and allows the invested amount to grow.
Low minimum SIP amount: There is a misconception that one can only invest a lump sum amount in an ELSS mutual fund. You can start an SIP with an ELSS fund with a minimum amount of Rs 500 per month.
ELSS offers diversification: ELSS funds often invest across companies of different market capitalisations (small-cap, mid-cap, large-cap) as well as companies from different sectors. Therefore, your ELSS portfolio would be adequately diversified.
Hedge against inflation: ELSS funds through long-term investment allows investors to earn a return greater than the inflation level and ensures that the value of their money is not declining. Over the last few years, interest rates offered by fixed deposits have been reducing and mutual funds are emerging as an alternative destination to park your funds.

How should one select the right ELSS fund?

Check the expense ratio: The expense ratio associated with any fund is an important factor to check before investing in it. A fund with a high expense ratio would eat into the returns earned by you and slow down the effect of compounding. Expense ratio of the fund and its peers should be compared to gain a better idea about the administrative costs associated with a fund.
Verify the risk rating: The risk appetite of each investor might differ. Investors must verify the risk associated with the ELSS fund in which they plan to invest. A fund with high returns may also possess a higher risk that may often result in volatility in the results and returns of the fund. An investor can also check key ratios of the fund (such as the Sharpe Ratio) to understand its returns versus the risks.
Check asset allocation: Although an ELSS fund invests in companies across market capitalisations and categories, investors need to be aware of the allocation of assets. A fund that is heavily invested in a particular industry or sector might be impacted if those industries or sectors face problems. Investors may also wish to check out the risk rating assigned to an ELSS fund before making a decision.
Vet the fund manager: The role of a fund manager is of the highest importance while investing in mutual funds. They would be responsible for most decisions, including exit decisions. Ideally, choose a fund manager with ample experience and having the ability to navigate through different market spheres. Avoid any ELSS fund that involves a frequent change of managers.
Consider past returns: Although past returns are not indicative of the future returns of any funds, one must check the historical performance of a fund against its peers in both bullish and bearish markets. This would allow an investor to build a consensus regarding the strength of the ELSS funds they are looking to invest in.

To sum up, it would be a good idea to diversify your mutual fund portfolio by including ELSS funds as they offer tax benefits as well as the opportunity to achieve your financial goals. Equity Linked Savings Schemes: High returns + tax savings (Part I).

Here's a look at Top 5 tax-saving ELSS funds:

What kind of goals can be achieved through ELSS?

Why is ELSS a great medium for achieving financial goals?

Lock-in period creates discipline: Unlike other modes of investment, one can watch the current valuation of one’s investment in the stock market on a daily basis. The volatility of the stock market may force novice investors to take rash decisions and ignore the benefit of long-term investing. ELSS inculcates discipline and allows the invested amount to grow.
Low minimum SIP amount: There is a misconception that one can only invest a lump sum amount in an ELSS mutual fund. You can start an SIP with an ELSS fund with a minimum amount of Rs 500 per month.
ELSS offers diversification: ELSS funds often invest across companies of different market capitalisations (small-cap, mid-cap, large-cap) as well as companies from different sectors. Therefore, your ELSS portfolio would be adequately diversified.
Hedge against inflation: ELSS funds through long-term investment allows investors to earn a return greater than the inflation level and ensures that the value of their money is not declining. Over the last few years, interest rates offered by fixed deposits have been reducing and mutual funds are emerging as an alternative destination to park your funds.

How should one select the right ELSS fund?

Check the expense ratio: The expense ratio associated with any fund is an important factor to check before investing in it. A fund with a high expense ratio would eat into the returns earned by you and slow down the effect of compounding. Expense ratio of the fund and its peers should be compared to gain a better idea about the administrative costs associated with a fund.
Verify the risk rating: The risk appetite of each investor might differ. Investors must verify the risk associated with the ELSS fund in which they plan to invest. A fund with high returns may also possess a higher risk that may often result in volatility in the results and returns of the fund. An investor can also check key ratios of the fund (such as the Sharpe Ratio) to understand its returns versus the risks.
Check asset allocation: Although an ELSS fund invests in companies across market capitalisations and categories, investors need to be aware of the allocation of assets. A fund that is heavily invested in a particular industry or sector might be impacted if those industries or sectors face problems. Investors may also wish to check out the risk rating assigned to an ELSS fund before making a decision.
Vet the fund manager: The role of a fund manager is of the highest importance while investing in mutual funds. They would be responsible for most decisions, including exit decisions. Ideally, choose a fund manager with ample experience and having the ability to navigate through different market spheres. Avoid any ELSS fund that involves a frequent change of managers.
Consider past returns: Although past returns are not indicative of the future returns of any funds, one must check the historical performance of a fund against its peers in both bullish and bearish markets. This would allow an investor to build a consensus regarding the strength of the ELSS funds they are looking to invest in.