Things to learn about ELSS, which is a tax saving mutual fund investment options.
ELSS is a popular choice among investor seeking to claim income tax benefits. Here are a few things you should know about them
February is a time to stake stock of all your tax-saving investments under Section 80C, since you have to make them before the end of the financial year on 31 March. If you haven’t made those investments, one option for you would be an Equity-linked Savings Scheme (ELSS), which has been a favourite among taxpayers because of its higher returns. ELSS funds are equity mutual funds that invest in a diversified basket of shares.
Here are some of the things you should know about ELSS funds.
Not all ELSS funds are the same
Sure, all ELSS funds give you the same tax benefit of a deduction of Rs.1.5 lakh, but there are significant differences in quality. Before you invest, you should check out returns over several time periods like one, three, five and ten years. Choose one that offers consistent returns over time. Several web sites like Moneycontrol.com offer such comparisons. The best funds have offered returns of around 15 per cent over a three-year period, and around 20 per cent over five years. You could also compare total expense ratios (TER), which could range from 1.5 per cent to a maximum of 2.5 per cent. Higher tiers will reduce overall returns for you.
Should you sell after three years?
ELSS funds have a lock-in period of three years, after which they can be redeemed. But should you redeem them soon after the three years are up? Unless you have a pressing need for that money, it’s better if you stay invested for the longer term. Equity yields the best returns when your investment in them is over a longer time period, say, 5-10 years.
Is the SIP route better?
You have two choices when it comes to ELSS investment. You can either invest a lump sum or through a Systematic Investment Plan (SIP). SIPs are a much better choice. For one, you can invest small amounts each month, and make the optimum use of your available funds. Two, there is the benefit of rupee cost averaging. Since the same amount is invested each month through a SIP, you get more units when share prices are low, and less when stock prices are high. Hence, you don’t have to worry about investing at a time when prices are abnormally high and losing out when they fall.
Tax on returns
Another thing to remember while investing in ELSS is that returns are subject to long term capital gains tax after you redeem them. This is unlike the Public Provident Fund (PPF), where interest is tax-free. You have to pay a tax of 10 per cent on gains from equity funds if they exceed Rs. 1 lakh in a financial year. So remember to space out those investments so that your long-term gains from equity and other instruments don’t exceed that amount during the financial year.
Risk and returnOne golden rule of investment is that higher the returns, higher will be the risk. The same is the case with equity. Equity has outperformed most other asset classes in the long term, but there are no guarantees that this will continue in the future. Equity is a good choice if you are younger and able to wait out any bear phase. If you are older – retired or close to retirement – a significant chunk of your income should be in low-risk fixed income instruments.
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