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ELSS — Simple tips to choose the right tax-saving fund

Indiarox

Here are a few factors involved to locate a fund which will fulfill your savings requirement in a holistic manner.

Archit Gupta

Equity-Linked Savings Scheme (ELSS) funds are multi-cap equity investments which have a lock-in period of three years. They provide you tax advantages along with wealth creation opportunities. Under Section 80C of the Income Tax Act, you can claim a tax exemption of up to Rs 1.5 lakh on the contribution made towards ELSS funds.

Considering numerous ELSS funds available, selecting the appropriate one for investment may become overwhelming at times. Usually, investors choose the fund which gives them best return over a given investment horizon. However, plain vanilla returns do not give the much needed picture to arrive at the best funds. There are certainly other factors involved to locate a fund which will fulfill your requirement in a holistic manner.

Things an investor needs to keep in mind

Investing in an equity fund like ELSS is similar to a long-term relationship. You need to be aware of what you are getting into. Following are some of the factors which will help you make an informed decision:

1. Do not go behind top performers

It is very easy to fall for the recent top performing funds. Such an impulsive decision is made based on annualised returns. Whatever returns you witness in fund disclosures relate to past performance. However, there’s no guarantee that it will be replicated in future.

Moreover, a fund which is a chart topper today may slide to lower ranks in the subsequent period. So, simply choosing the best performing fund may or may not help you in achieving your financial goals. Rather than depending on the recent returns, analyse fund performance across multiple horizons.

Look for the fund returns in a period which matches your investment horizon. Say if you want to stay invested for five years, examine five year fund returns. Check for consistency of returns and strength of the fund during market slump and rallies.

2. Analyse risk-return framework

According to the risk-return principle, higher risk should be compensated by higher returns. When you invest in a fund, you need to look for its risk-return potential. Ideally, the fund needs to generate higher returns for every additional unit of risk taken by it. The risk-reward framework of a fund can be easily ascertained by using Sharpe Ratio. It shows how much additional returns the fund will give you for the extra risk absorbed.

You may find Sharpe Ratio in the fact sheet of a mutual fund. Among all the competitive funds of similar risk category (say large-cap equity funds), the one with the highest Sharpe Ratio is superior to others. It shows that the fund will compensate you in a better manner for the additional unit of risk assumed

3. Check composition of the fund

Fund composition tells you about what kind of assets/securities the fund is made up of. A diversified equity fund like ELSS invests in a number of securities across various industries and market capitalisation. The fund manager tries to maintain a well-diversified portfolio to reduce firm related risks involved.

However, you cannot get rid of market risks. The portfolio composition of ELSS is guided by its investment objective. But, no two ELSS funds would have the same portfolio composition. You will find that some funds have concentrated holdings in a few sectors as compared to others.

This means that in spite of falling in the same category, an ELSS fund heavily invested in small-cap stocks will be riskier than the fund which is concentrated in large-cap stocks. Before choosing a fund, you need to match the fund’s risk profile with your own risk tolerance. Thus, a risk seeker’s fund choice will be completely different from an investor who is less risk aggressive.

The bottomline

You may end up in a wrong fund due to a hurried selection. Investment in ELSS funds has to be a well thought out decision after considering all the factors.

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