Are You Investing in the Right Tax-Saving Mutual Funds?

Jun 29, 2022

Listen to Are You Investing in the Right Tax-Saving Mutual Funds?

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The beginning of a financial year is the ideal time to start planning your tax-saving investments. However, most taxpayers procrastinate on their tax-saving plan till the last quarter of the financial year. Due to the last-minute hassle, many individuals end up making knee-jerk investment decisions at the end of the financial year to reduce their tax burden, which may result in insufficient tax savings and stress. If you want to lower your tax obligations while still achieving your wealth-creation goals, using the right tax planning strategy is essential.

Under Section 80C of the Indian Income Tax Act, you can claim tax benefits on certain expenditures and investments. While there are several other options under 80C, such as PPF, National Savings Certificate (NSC), bank tax-saving deposits, and life insurance plans (ULIP) etc., that assist in reducing your tax liabilities, tax-saving mutual funds or ELSS have gained traction in the past few years.

You can reduce your tax liabilities under Section 80C of the IT Act by using tax-saving mutual funds or Equity Linked Savings Schemes (ELSS). You can invest in these schemes and claim tax deductions on your investments every financial year up to a maximum of Rs 1.5 lacs. Under mutual funds, Equity-Linked Savings Schemes (ELSS) are specifically designed for tax savings.

Benefits of investing in Tax-saving Mutual Funds or ELSS:

  • Lowest Lock-in period - One of the major reasons why investors consider Tax saving mutual funds or ELSS is because of their lower lock-in period of 3 years. In comparison, a tax-saving fixed deposit (FD) has a lock-in period of 5 years, a public provident fund (PPF) has a lock-in period of 15 years, a national savings certificate (NSC) has a lock-in period of 5 years, and the National Pension Scheme (NPS) has a lock-in period that lasts until retirement.

  • Dual Benefit - Wealth creation and tax benefits are two advantages of investing in ELSS. ELSS is a market-linked tax-saving instrument that invests the majority of its equities, providing investors with the opportunity to reap tax benefits as well as generate optimal returns.

  • Minimum Investment - Investors can invest as low as Rs 500 in ELSS via Systematic Investment Plan (SIPs). It is advisable to choose the SIP method as investors can invest in small amounts systematically and avail of the benefits of rupee cost averaging.

  • Diversification - ELSS mutual funds invest the majority of their assets in equity and equity-linked instruments across sectors and market caps, thereby diversifying a portfolio. This diversification helps prevent huge losses during highly volatile market conditions.

  • Taxation - After the lock-in period of 3 years, the long-term capital gains (LTCG) of up to Rs 1 lac in a year from ELSS mutual funds are exempt from income tax. Additionally, Long Term Capital Gains above INR 1 lakh is taxed at 10%.

Although ELSS provides various benefits as compared to other traditional tax-saving avenues and has historically generated attractive returns, it may not be suitable for everyone.

Are You Investing in the Right Tax-Saving Mutual Funds?
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All mutual funds are subject to market risks, especially equity funds, and so is ELSS. Do note that an ELSS invests over 80% of its assets in equity and equity-related instruments that are highly risky in nature due to market volatility. These funds do not offer guaranteed returns as they are high-risk-return investments investing in market-linked instruments and depending on the performance of underlying securities. However, if invested for the long term, they can beat market instability and offer decent returns to the investors.

ELSS is an equity-linked product that may go through periods of sharp volatility, and investment returns can see sharp fluctuations in short to medium-term horizons. Investors should have a flexible long-term horizon as they may need to retain their investments in ELSS until the market has recovered in order to gain optimal returns.

Keep in mind that investment in equities offers significant returns over the long term. Although the lock-in period for ELSS is 3 years, it is advisable to invest for a timeframe of around 5-7 years to reap long-term benefits. Young investors who are early into their career and have a longer tenure to stay invested can take the maximum advantage of ELSS mutual funds.

Investing in a tax-saving avenue based on your risk profile and investment horizon is essential for every taxpayer because it will lead to an effective tax-saving plan. Hence, ELSS funds are suitable for taxpayers willing to take the risk of an equity-oriented tax-savings instrument.

In my view, It is wise to invest in tax-saving instruments only after assessing your risk profile, investment horizon and objectives, instead of investing in an ad hoc manner. Selecting suitable worthy tax-saving investments can be a valuable addition to your investment portfolio and this could even assist you in achieving your envisioned financial goals.

In order to gain maximum tax benefits and build wealth simultaneously, you need to ensure to invest in the right tax-saving mutual funds or ELSS as per your suitability. Now you must be wondering how to identify the right tax-saving mutual funds?

Well, there are a few factors you should consider before investing in tax-saving mutual funds or ELSS:

1. Performance Track Record

Investors should carefully analyse the ELSS fund performance track record and after careful consideration make an investment depending on their financial goals and risk appetite. Analysing past performance helps to determine how the tax saver scheme has performed and helps investors make an informed investment decision.

In the case of ELSS, there is a lock-in of 3 years, while it is advisable to hold a fund for at least five years as short-term investments in equity could be risky. As a result, you need to evaluate how the fund has performed over the long term across various market cycles and don't be guided by the short-term performance of a scheme. Investors should look for at least 5-7 years of performance track record and how long the fund manager has been at the helm of the fund. However, past performance is not an indicator of how a fund will perform in the future.

2. Expense Ratio

The expense ratio is the amount of investment that goes into managing the funds. The expense ratio should be carefully considered by an investor because it can directly affect the returns generated. The lower the expense ratio, the higher would be the returns and vice-versa. In the case of two funds with a similar track record and asset allocation, one can consider a fund with a lower expense ratio.


3. Assess Portfolio attributes

Not all ELSS funds have the same portfolio holdings; some emphasise large-cap equities while others have a decent balance of large, mid, and small stocks in their portfolios. You must look at the underlying asset allocation of the ELSS funds, a multi-cap portfolio with a predominance of large-cap is a better option for the long term. The portfolio mix also determines the risk-reward ratio for investors.

4. Grab the SIP Advantage

If an investor is investing at the beginning of the financial year, one can either invest in a lump sum or via the SIP route. ELSS are equity schemes, and monthly SIPs are the best way to invest in these funds. SIP involves regularly investing small amounts of money in a disciplined way and is advisable if one is a first-time investor. Investing via the SIP route helps lower the risk as investments are spread over a longer time period.

Additionally, Due to rupee cost averaging, investors can obtain a better average price for their units by investing at various NAVs throughout the year rather than all at once with a lumpsum investment at the end of the financial year.

Tax saving benefits, the potential for long-term wealth creation, and a comparatively lower lock-in period make ELSS mutual funds a great investment choice for investors. Investors should thoroughly research and assess their long-term and short-term financial goals and risk appetite before investing in the best ELSS funds.

When deciding on the best ELSS, do not be influenced merely by the returns. You should consider to evaluate the various quantitative and qualitative parameters and compare the fund's performance to its peers. This will confirm how consistent the tax-saving mutual fund or ELSS performance has been in the past and indicate if the fund house follows robust investment processes and systems.

Therefore, as you begin tax planning for FY2022-23, it's far more vital to make sure you are investing in the right tax-saving mutual funds and that your tax investments are in line with your financial plan.

However, if you are not sure about how to exercise your tax planning, save yourself from the last-minute stress and initiate your tax planning with the help of PersonalFN's Definitive Guide to Select ELSS (Edition 2022).

This Guide will show you how picking a worthy ELSS, a Tax-saving Mutual Fund, could potentially maximise your wealth and act as an effective tool for tax planning. It includes:

  • Why ELSS is a worthy option for tax planning

  • Mistakes to avoid while investing in ELSS

  • How to select the best ELSS for tax planning

  • How ELSS have performed as a category

  • Some of the best ELSS to invest in

  • Who should consider investing in ELSS

  • How should one go about investing in ELSS

If you are looking to exercise your tax plan and invest in tax saving funds for the year 2022, then get your free copy of To PersonalFN's Definitive Guide to Select ELSS (Edition 2022).


Warm Regards,
Mitali Dhoke
Jr. Research Analyst

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