Though all equity diversified funds that offer a tax break are classified as equity linked savings schemes, or ELSS, all funds are not the same.
For one, you need to check the market cap of the fund. For instance, Mirae Asset Tax Saver has around 72% of its portfolio in large caps, HSBC Tax Saver has around 34% in mid and small caps, and Edelweiss ELSS has 44% of its portfolio in mid and small caps. Depending on what market cap you are comfortable with and which fits in with your portfolio, search for a fund accordingly. For instance, if your portfolio is packed with large-cap funds, you can opt for an ELSS which tilts towards smaller fare.
On similar lines, check whether the fund manager takes big bets or prefers going with a diversified portfolio, and see where your comfort level lies.
For example, the top 10 stocks in JM Tax Gain corner over 51% of the portfolio. The portfolio is completely invested in around 30 stocks. Edelweiss ELSS has just around 32% of its portfolio in the top 10 stocks and sports a portfolio of around 64 stocks.
So check how concentrated the top holdings are and how tight the portfolio is.
Depending solely on latest performance numbers can mislead
The tax advantage of ELSS
Do you want a mid- or large-cap tax-saving fund?
Invest in ELSS with a long-term perspective
Depending solely on latest performance numbers can mislead
As with any fund investment, when narrowing down on an equity linked savings scheme, or ELSS, an error investors are prone to make is opting for the most recent chart topper. Despite the bold disclaimers about past performance not necessarily being sustained in the future, investors have a hard time resisting that lure. And when that is employed as a sole parameter, it’s not uncommon for disillusionment to set in rapidly.
Let’s say in 2008 investors rushed to invest in Taurus Tax Shield. The reason being the fund was the best performer in its category in 2007 with a return of 112%, way ahead of the average 57%. Had investors done their homework, they would have noticed the fund’s abysmal performance in 2006. And, unfortunately, the fund has not put up an impressive performance since.
Or take Principal Tax Savings. It was the best fund in its category in 2012. But a smart investor would have checked past performance to realise that it underperformed the category average over the prior four calendar years.
When looking at performance, don’t get swayed by a sporadic burst in numbers.
The tax advantage of ELSS
Investments in Equity Linked Savings Schemes, or ELSS, are eligible for a tax break under Section 80C of the Income Tax Act. What this means is that the amount you invest gets you a tax deduction. You can go up to Rs 1.50 lakh which is the limit under this section.
Since the minimum lock-in period of ELSS is three years, investors end up paying zero tax since long-term capital gains in equity is nil.
So there is no tax to be paid on the returns and at the time of investment, the investor gets a tax break under Section 80C.
Do you want a mid- or large-cap tax-saving fund?
Though all equity diversified funds that offer a tax break are classified as ELSS – which is an acronym for Equity Linked Savings Schemes, all of them are not the same in terms of portfolio construction. It would be a grave investing error to assume that all funds in this category are similar.
Since they are actively managed, the fund manager has the leeway to decide on what must comprise his portfolio. It could be a large-cap oriented fund or a mid-cap oriented one or even a flexi-cap fund. One fund’s investment mandate will not be the same as the other.
For instance, Mirae Asset Tax Saver has around 72% of its portfolio in large caps, HSBC Tax Saver has around 34% in mid and small caps, and Edelweiss ELSS has 44% of its portfolio in mid and small caps.
If you are looking for a mid-cap fund, then search for a tax-saving fund which has such exposure to smaller fare. If you prefer playing it safe with large caps, then search for such portfolios accordingly.
But remember, the only similarity you can take for granted is that they are open ended, actively managed equity funds that have a lock-in period of three years. The rest is up to the portfolio manager.
Invest in ELSS with a long-term perspective
Equity linked savings schemes, or ELSS, are actively managed diversified equity funds. As with any equity fund, it is recommended that you have a long-term perspective in mind, preferably five years at the minimum.
Equity, as an asset class, always carries with it the risk of loss of capital. But this risk is pronounced when you invest with a very short-term perspective in mind. For instance, if we look at the 1-year return, the category average is -11%, with the worst performer (Reliance Tax Saver Div) delivering a gut-wrenching -19.22%. However, it all changes when you stay in for the long haul. The very same fund delivered annualized returns of 21% over 3 years, 15% over 5 years and 12% over 10 years.
The figures below shows the average category annualized returns over various years.
- 15 years: 19%
- 10 years: 9.69%
- 5 years: 11.50%
- 3 years: 16%
- 1 year: -11%
So even when the 3-year lock-in period expires, you need not exit your investment. If the market dynamic favours you and you need the money, then do so. But otherwise, hold on till the market picks up. Remember, there is no pressing need for redemption once you complete the mandatory lock-in period.