Investing in mutual funds requires an investor to conduct due diligence. This is the case with all types of mutual funds, evenness tax saving mutual funds. You might have frequently experienced experts asking you to be cautious when selecting ELSS tax-saving funds. This article aims to serve as an investment guide in helping you choose the right ELSS fund for your investment portfolio. But, before we proceed, let us quickly recollect about ELSS mutual funds.
What are ELSS mutual funds?
ELSS funds are tax-saving mutual funds that invest most of their investible corpus – a minimum of 80% of their assets in equity and equity-related securities. These mutual funds are entitled for a tax deduction of up to Rs 1.5 lac u/s 80C of the Income Tax Act, 1961. By investing in ELSS funds, an investor can save up to Rs 46,800 per annum provided that they fall in the highest tax slab. Thus, ELSS funds provide an investor with the dual benefit of capital appreciation and tax-saving attributes.
How to choose the right ELSS tax saving mutual funds?
Following are some tips that an investor can adopt before investing in ELSS mutual funds:
Stop hunting down top performers
It is easy to be drawn towardsthe top-performing mutual funds. Such imprudentchoices are often made basis the annualreturns of a fund. However, there is no assurance that similar returns would be achieved in the future.
What’s more, a fund that is performing
exceptionally well today might produce significantly lower returns in the succeedingquarter.
Hence, instead of considering recent returns, take into account the performance
of the scheme across multiple horizons.
Analysethe risk-return ratio of the scheme
According to the risk-return
principle, a higher level of risk is usuallyrewarded by a higher degree of
returns. So before investing in ELSS funds, look for its risk-return potential.
The risk-reward ratio can be determinedvia the Sharpe Ratio. It illustrates
the potentiality of returns produced by a scheme for the extra level of risk
taken.
Check the composition of the fund
Composition of the fund depicts the type of securities or assets a particular fund is made of. A diversified equity fund such as ELSS fund must invest in different securities spread acrossvarying market caps and industries. Remember, that you cannot get rid of all market risks when investing in mutual funds., specially an equity-based mutual fund. No two ELSS funds have same fund composition. So, if you are keen on achieving high returns even if that meant undergoing higher level of risk, choose a fund with a higher allocation to small-cap funds. However, if you are a risk-averse investor, you might consider selecting an ELSS fund that majorly invests in large-cap stocks.
It is always advised to cautiously analyse a mutual fund investment before investing in them to avoid making wrong choices. As a good practice, ensure that your investments are in line with your investment horizon, risk appetite, and financial goals or objectives. Happy investing!