Investments in ELSS mutual funds or Equity Linked Savings Schemes enable investors to claim deductions of up to Rs 1.5 Lakhs from the taxable income as per Section 80C of income tax act 1961. Equity Linked Savings Schemes (ELSS) are one of the best tax saving investment options as they offer investors triple advantage of superior long term returns, friendlier tax treatment of maturity corpus and higher liquidity. In the blog post, we will discuss some common mistakes which ELSS investors must avoid.
Do not make your ELSS investment at the end of the financial year: If you wait till the final month or quarter of the financial year to make your tax saving investments, then you will lose a lot of returns. Let us discuss this with the help of an example -
Suppose you have to make Rs 1 Lakh of tax saving investment ELSS Mutual Funds every year for the next 12 years. What will be the maturity corpus after 15 years (when the lock in period for the last investment ends) assuming 15% annualized returns and no redemptions in the interim? If you make your ELSS investments at the end of every financial year, your maturity amount will be Rs 44 Lakhs. On the other hand, if you make your ELSS investments at the beginning of every financial year, your maturity amount will be Rs 50 Lakhs. You should try to make your tax savings investments at the beginning of the financial year to maximize your returns. If you do not have sufficient lump sum funds at the beginning of the financial year, then monthly Systematic Investment Plan (SIP) will be the best option for you.
You must read: 5 reasons why you should invest in tax saving mutual fund SIPs
ELSS is not just for tax savings: Tax savings should not be the only objective of investing in ELSS Mutual Funds. ELSS Mutual Funds invest in equity securities and as such,are subject to market risks. There may be periods when ELSS will give negative returns, but over a long investment horizon equity as an asset class is likely to give much higher returns than fixed income (the Sensex gave 16% annualized total returns in the last 10 years). Your investment decision should not be dependent on prevailing market conditions. You must invest in ELSS according to your risk appetite and be prepared to hold for a long period of time to create wealth.
Do not redeem immediately after the lock-in period unless you need money: ELSS has the shortest lock-in period (3 years) among all 80C tax saving investment options. However, this does not mean that you should redeem immediately after the lock –in period, unless you need money for some other financial needs, you should remain invested in your ELSS Mutual Fund investments till your wealth creation objective is met. The longer you remain invested, the more wealth you will be able to accumulate.
Do not select ELSS funds based on short term performance: Many investors select mutual fund schemes based on the last 1 or 2 year performance. Mutual fund returns for a particular period are dependent on a variety of market driven factors and the fund manager’s investment strategy, in co-ordination with market conditions prevailing at that period in time. A scheme which gives high returns in the short term may not necessarily be able to sustain it when conditions change. Investors should always select mutual fund schemes including ELSS Mutual Funds based on the long term track record of the scheme and the fund manager.
Do not over-diversify your ELSS investments: You may decide to invest in ELSS Mutual Funds every year for tax savings but avoid investing in too many schemes. An ELSS fund portfolio is itself diversified across market cap segments and industry sectors; investing in many schemes will not necessarily give you additional diversification benefits. On the other hand, if you invest in many schemes, you will have to spend more time monitoring their respective performances and calculating your capital gains tax. Further, some schemes may underperform and your overall portfolio performance may suffer. If your ELSS Mutual Funds is giving you good returns, stick to it for additional tax saving investments. If your scheme is underperforming versus its benchmark and peers over a sufficiently long period, then switch to a better performing scheme.
The important takeaways are:-
- Start your tax planning early and make your tax saving early in the year or through monthly SIP.
- Invest according to your risk appetite and be prepared for intermittent volatility.
- Redeem only when you need money irrespective of lock-in status and be prepared to remain invested for the long term.
- Select ELSS Mutual Funds based on their long term track record and performance consistency.
- Avoid investing in too many funds.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.
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