ELSS are considered an efficient tax savings instrument because:
- They have the shortest lock in period (3 years) among tax saving instruments that have a minimum lock in of 5 years
- It is convenient to invest in an ELSS through the systematic investment plan (SIP) route, like any other MF scheme
- ELSS have the potential to provide good returns and thus create wealth in the long term
Further, investment in an ELSS can be tied to long term goals. You can thus invest in ELSS SIPs in small amounts, that contribute towards building a retirement corpus, or saving for education of your children. However, it is important to be aware of some common mistakes while doing tax saving mutual funds investment and learn how to avoid these mistakes.
Looking for top performers
The first mistake to avoid is at the selection stage. Do not look for ‘top performers’ on mutual fund aggregator websites. Instead, consider the schemes that have rendered consistent performance as compared to both its benchmark and peers. Consider a time frame of at least five years to make a fair comparison.
Not looking at the portfolio composition
Not looking at the portfolio of the scheme you are investing in, is another crucial mistake. Investing in an ELSS scheme that is not in sync with your own risk appetite may have disastrous consequences later. For instance, if you are an investor with a conservative risk appetite, it is wise to stay away from an ELSS with an aggressive portfolio for higher returns. It is thus important to check the scheme information document (SID) and study the portfolio of the scheme before you invest.
Redeeming units after mandatory lock in
ELSS have the potential to create wealth for the long term. Thus, do not be in a hurry to redeem your investment after the mandatory lock in. If your fund is a consistent performer, consider remaining invested for five to seven years at least, to reap better returns.
Switching funds every three years
Opting out of an ELSS to switch to another similar scheme after the compulsory three years lock in period is another mistake to avoid. If your fund is underperforming consistently, the decision to move may be justified. However, if the underperformance is due to overall macro-economic conditions, the decision to switch will work against you.
Waiting till the end of the year to invest
Lastly, and perhaps most importantly, don’t wait till the end of a financial year to make an investment in an ELSS. By doing so, you may be forced to enter at a time when market conditions are not favourable. You may thus have to pay a higher price for the MF units. Stay away from the risk of timing the market, by investing at the beginning of the year through SIPs instead. Investing consistently through SIPs also maximises your return potential.
Now that your introduction to tax saving mutual funds is complete, you can make an investment in an ELSS of your choice for efficient tax planning.