How to Pick the Right ELSS Fund?

Are you looking for a good tax-saving investment to save tax and build wealth? Do you fall in the higher income tax brackets and seek a tax-efficient investment? You could invest in Equity Linked Saving Scheme or ELSS to save tax and attain long term financial goals. It invests mainly in stocks and qualifies for the Section 80C tax deduction. However, every ELSS is unique based on the investment style and the market capitalisation of stocks in its portfolio. How to pick the right ELSS Fund?

What is an Equity-Linked Saving Scheme?

The Equity-Linked Saving Scheme is a tax saving mutual fund that invests at least 80% of its assets in equity and equity-related instruments. It qualifies for the Section 80C tax deduction up to Rs 1.5 lakh per year. 

ELSS is a diversified equity fund that invests in stocks across market capitalisation and sectors. Moreover, it has a three year lock-in period which ensures you stay invested in ELSS for the long term. 

You can invest in ELSS through the systematic investment plan or SIP. It is a facility offered by mutual funds where you invest small amounts regularly in a mutual fund. It helps you average out the purchase price of ELSS units over time, called rupee cost averaging. 

How to pick the right ELSS Fund?

ELSS funds invest in large-cap, mid-cap and small-cap stocks. You must select the ELSS based on your risk tolerance. For instance, aggressive investors could select ELSS with a higher mid-cap and small-cap component. However, conservative investors could opt for ELSS with a bias towards large-cap stocks. 

You must check the investment style of the ELSS fund before investing your money. For example, the ELSS may follow a growth, blend or value investment style. Depending on your investment objectives, you could opt for ELSS, which invests predominantly in growth stocks or value stocks. 

For instance, with a value focus, ELSS selects stocks of companies that are currently trading below their fundamentals. However, they will rise in value over time as investors discover their true potential. 

You must pick ELSS, which consistently outperform the benchmark and peers over time. Moreover, you must check the track record of the fund house and the fund manager. It helps if you select ELSS with a lower expense ratio to increase your overall returns over time. 

You must check if the ELSS follows a concentrated or diversified strategy. For instance, ELSS funds that follow a concentrated strategy may have a maximum of 30 stocks in their portfolio. However, other ELSS funds which focus on the diversified strategy will have up to 60-65 stocks in their portfolio. Aggressive investors may look at a concentrated strategy, whereas conservative investors prefer a diversified strategy. 

Why invest in ELSS?

ELSS is a tax-efficient investment for investors in the higher tax brackets as long term capital gains up to Rs 1 lakh are tax-free. You could save up to Rs 46,800 if you fall in the highest tax bracket and invest Rs 1.5 lakh per year in ELSS. 

You don’t need to invest a lump sum amount in ELSS. Mutual Fund Houses allow you to invest as low as Rs 500 per instalment in ELSS through the SIP. Moreover, small regular investments won’t pinch your wallet compared to a lump sum investment. 

ELSS offers you an opportunity to benefit from the power of compounding. It helps if you purchase ELSS units and stay invested long-term. You earn a return on the principal amount and the returns you make over time. 

ELSS funds have the potential to offer inflation-beating returns. However, you must pick the right ELSS, or you will lose an opportunity to build wealth over time. You must not choose ELSS funds based on past performance. It helps if you evaluate funds based on your risk profile. In a nutshell, every ELSS fund is unique based on market capitalisation, number of stocks in their portfolio and investment style. 

For any clarifications/feedback on the topic, please don’t hesitate to contact the writer at cleyon.dsouza@cleartax.in.