Prudent investments can indeed help one to build their wealth profile in the long term. Tune in to today's MoneyControl podcast to understand ELSS funds
Wealth creation is a complex subject, one that has inspired self-help books, films and seminars by financial gurus who have built multi-million dollar empires telling people how they can get rich quick. And of course, there are podcasts offering sage advice as well, like the one that you are listening to right now.
Prudent investments can indeed help you build your wealth profile in the long term. This is Seetal and in today's Moneycontrol podcast, we will talk about one such investment option.
Now let us get to the saving scheme everyone seems to be talking about
Equity-Linked Savings Scheme (ELSS) funds are multi-cap equity investments that seem to be gaining currency with investors. ELSS funds are a type of mutual funds which base their returns from the equity market and are promoted by the government to encourage long term equity investments.
An indiainfoline.com piece informs that there are two categories in ELSS mutual funds i.e. dividend and growth.
The dividend fund is further divided into Dividend Payout and Dividend Reinvestment.
We quote from the piece, " If an investor opts for a dividend payout option, he receives the dividend which is also tax-free, however, under the dividend reinvestment option, the dividend is reinvested as a fresh investment to purchase more shares. Under the growth option, an investor can look for long term wealth creation. It works like a cumulative option whose full value is realized on redemption of the fund." Unquote.
ELSS funds have a lock-in period of three years and provide investors with many tax advantages. What is more, under Section 80C of the Income Tax Act, investors can claim a tax exemption of up to Rs 1.5 lakh on the contribution made towards ELSS funds.
So how do you go about choosing from a diverse bouquet of ELSS funds available?
Recently, a MoneyControl piece written by Archit Gupta, Founder and CEO of ClearTax.com outlined a few important steps investors should know before investing in ELSS
We quote the author, "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. " Unquote.
He offers some suggestions as to how to make an informed decision:
He cautions first of all that investors should not make a beeline behind top performers.
It is easy to be tempted by top performing funds and possible annualised returns. Says the author, "Whatever returns you witness in fund disclosures relate to past performance. However, there’s no guarantee that it will be replicated in future.
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."
The next step is to carefully analyse risk-return framework. Says the author, "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 factsheet 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." Unquote.
Checking the composition of the fund is the next crucial step because it informs you of the kind of assets/securities that the fund is made up of.
ELSS is a diversified equity fund and invests in a number of securities across various industries and market capitalisation, says the article and the fund manager tries to maintain a well-diversified portfolio to reduce firm related risks involved even though there is always the looming shadow of market risks. The portfolio composition of ELSS is guided by its investment objective but says the author, 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, an investor needs to match the fund’s risk profile with their risk tolerance.
The point is to not select a wrong fund in a hurry.
ELSS can be invested in via two methods i.e. lumpsum or SIP.
In the SIP or Systematic Investment Plan, the investor invests a fixed amount of money every month at a specified date.
We refer back to the indiainfoline.com piece to understand just what is significant about the lock-in period of three years in ELSS and what are some of the other features that investors need to know about.
We quote, "ELSS funds have a lock-in period of three years. When compared to EPF, PPF, NSC and other prevalent investments under Section 80C, ELSS has the shortest lock-in period. Dividends earned from ELSS funds are also exempted from tax. ELSS funds also provide the benefit of long term capital gains. One can start investing in ELSS mutual funds with a minimum amount of Rs500, and there is no upper limit on how much a person can invest in ELSS funds. However, the tax saving ceiling is only up to a maximum of Rs1,50,000 a year." Unquote.
Don't look for guarantees but stay optimistic.
And that holds true for life and investment decisions. Says the indiainfoline piece, "ELSS mutual funds do not have ironclad guarantee over returns, as they generate their earnings from investments in the equity market. Nevertheless, some of the best performing ELSS mutual funds have given consistent and inflation beating returns in the long run. This quality is not possessed by the other fixed income tax saving investments like PPF and FD." Unquote.
All things considered, experts reckon and as does the indiainfoline piece that
ELSS mutual fund investment is not just a tax saving investment under Section 80C, but and we quote, " also ideal for retirement planning and wealth creation coupled with the benefits of lower lock-in period, SIP method of investment, rupee cost averaging risk and no tax on dividends or the benefit of capital gains. ELSS funds should be taken into account by every investor while planning their investment goals." Unquote.
Another piece in scripbox.com offers the final piece of the ELSS puzzle and advises that ELSS funds are for all practical purposes equity mutual funds and should be considered for long term benefits. Withdrawing them after three years is not the best approach to take. Allow them at least 7 years to get the most benefit out of them, suggests the article.
But before we get there, let us start at the very beginning
A Business Insider article published in June advises beginners to start with the basics.
For instance, the author suggests preparatory steps before jumping into any kind of investment commitment.
Starting with surveying the current status of earnings, setting aside an amount that can be invested and setting your short term, medium term or long term financial goals.
Knowing your risk profile is another key step, which basically entails assessment of a few factors:
Business Insider first refers to Risk capacity which is the level of financial risk that an investor can afford comfortably based on his/her life situation.
Then comes Risk tolerance or investor's ability to cope at a psychological level with the volatility of capital markets.
The third factor according to Business Insider is Risk requirement which is the risk that is associated with the level of return that the investor is seeking to achieve to fulfil their financial goals within the constraint of limited financial resources.
We quote from the article, "Once you know your risk profile, you can ascertain what kind of investor you are, what kind of returns you should expect from your investment portfolio and what kind of investment portfolio you should have. Investors who want no risk to principal should not invest using stocks. Stocks may have attractive long-term potential, but investors must be willing to bear fluctuations in the market. Certificates of deposit (CDs) offer comparatively lower returns, but the principal amount is guaranteed. Each investment has an appropriate level of risk that can be measured using financial statistics. Standard deviation, beta and alpha can be helpful for investors looking to measure risk and volatility of a particular investment or portfolio." Unquote.
We further quote, "A good financial plan aligns your goals with the capacity to take investment risks and risk tolerance. " Unquote.
The next step, says the article is the creation of an investment plan through which the investible amount can be used to buy investment products on a regular basis, while maintaining the principle of diversification to minimise the risk incurred.
Business Insider suggests next that prospective investors choose an appropriate asset mix in line with the risk appetite of the investor.
Then comes choosing the right investments and reviewing your investment plan in a timely manner and if any of the constituents are not performing up to the return expectation then making the decision to replace that asset after careful review. Says Business Insider, "Such alterations should not be made very frequently as for some assets there may be entry or exit load which may decrease the value of portfolio." Unquote.So do some brainstorming, strategise, go over the fine print and invest carefully in decisions that will give you long term security and send you laughing all the way to the bank.