Equity Linked Saving Scheme (ELSS) is a particularly popular tax-saving instrument, mainly because of having the lowest lock-in period among the options available under Section 80C. Even so, there are hundreds of options available and choosing the one that’s right for you can be a huge task- unless you know what exactly to look for. Read on to help yourself make a decision.
1. Lock-in Period
Even though ELSSs are mostly popular for the attractive 3-year lock-in period, it is suggested to hold on for at least 5-7 years.
While most people plan to invest for the minimum possible time for the purpose of tax deduction, be sure to check how this investment fits into your financial plan and helps you meet your short term and long-term goals. Since your deduction is just one part of your overall financial plan, you probably wouldn’t invest in an Equity linked fund, be it any scheme, for just 3 years as they are heavily influenced by the market. A volatile market may spell disaster for your 3-year investment horizon. Make sure you plan to invest for at least 5-7 years (with diversification) for no other reason than you investing in an Equity linked fund. In other words, don’t limit your use of ELSS to just tax saving.
2. Track Record
Investors normally tend to judge a fund by its historical performance. While this helps get a fair idea, it definitely shouldn’t be basis to judge your fund, especially when dealing with ELSSs.
More than how one fund has done in isolation over time, it is recommended that the investor judges the fund by its risk adjusted CAGR (returns) along with the bigger picture of how it performed in comparison to benchmarks and across market cycles to get a better picture. This becomes crucial due to the mandatory lock-in period.
3. Dividend vs. Growth option
Your tax deduction fund is still an investment fund and should be treated as such. A growth option automatically re-invests your gains back into the fund, thus increasing the NAV over time. This allows you to leverage the power of compound interest to gain exponentially greater returns over a longer period of time.
The power of compound interest is the tool even Warren Buffett attributes his success to. The dividend option gives out regular dividends to investors whenever enough profit is made, to the discretion of the fund manager. This option may be perfect for those looking for a source of regular income.
4. Risk Appetite of the Investor
Most ELSS funds are identical in terms of the lock-in period and the tax benefit, but there will be stark differences in terms of portfolio composition. For this reason, it becomes important for the investor to choose a fund on the basis of their financial goals and risk appetite.
1. Large cap funds generally embody less risk and more stable, while small cap funds tend to be riskier.
2. See how diversified the fund is. Unless you have research suggesting tremendous future growth in a particular sector or company, its always safer to invest in a more diversified portfolio.