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How to choose an ELSS fund?

If you are looking for a tax saving scheme which also delivers above average returns, Equity Linked Savings Scheme or ELSS is worth considering. ELSS provides tax benefits under section 80C of the income tax act.

These schemes have a three-year lock in period, during which you cannot sell, redeem or switch them. The lock-in period of ELSS is quite low, if you compare that with the Public Provident Fund (PPF) which has a lock-in period of 15 years, and the National Savings Certificate (NSC) lock-in period of 5 years.

Since it is a diversified equity fund, at least 65% of the fund’s assets will be invested in the stock market across sectors and industries. Your fund manager will decide whether to focus on a large-cap, mid-cap or even a flexi-cap fund. The minimum application in some of the ELSS fund is Rs 500, and you can either make a lump sum investment or opt for a Systematic Investment Plan (SIP).

Keep in mind, that for SIPs, each instalment has a three year lock-in, and as per the Budget 2018 guidelines, there is a 10% long-term capital gains or LTCG tax applicable if equity gains exceed Rs.1 lakh a year. While it is always advisable to have a long term investment horizon for maximum returns, ELSS gives you potential liquidity after three years.

Before you invest, keep in mind that as with all equity linked investments, there are market risks involved. To take just one example, small cap funds can potentially give you higher returns when the economy and markets are moving up, but are volatile and vulnerable when there is a slowdown.

Apart from market trends, here are a few things to consider while choosing an ELSS fund.

The first thing to ensure is that the funds have a minimum of three to five year track record, to allow you to map their potential. It helps to look for schemes from mutual fund houses with strong, proven investment systems and processes. Evaluate schemes on the basis of independent research ratings and / or risk reward ratios like Sharpe ratio, Treynor ratio, Sortino Ratio etc.

It is also important to keep in mind that under the new personal tax regime which kicks in from the FY 20-21, you will have the option of choosing a new flat rate, which is lower than the existing income tax slabs provided you are willing to forego tax exemptions and deductions. So if you are only looking for tax exemptions, you will have to calculate which option suits you better in terms of benefits. However, if you are looking for long term investments (with or without tax benefits) with fairly high returns and nominal risk, ELSS is still a good option. It is better to consult specialists before deciding which scheme to opt for based on your income and investment goals.

Disclaimer: The contents herein mentioned are solely for informational purpose and shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon.

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