If you look at the retail flows into equity funds and ELSS funds, we have seen the flows continue at elevated levels even after the imposition of 10% tax on LTCG. Most investors have realized that the impact of this tax on ELSS over the longer term is quite limited and that is a risk they can live with. Today, most salaried tax savers prefer the combination of returns and tax efficiency that ELSS funds offer. On top of that, you also get the lowest lock-in period of 3 years compared to other Section 80C products. But there are some common mistakes to avoid when investing in ELSS funds. Remember, investing in ELSS mutual funds is not only simple but also very productive. But for that, you need to know how to invest in ELSS and how best to avoid the typical pitfalls of ELSS investment. Here are 5 mistakes you must necessarily avoid while investing in ELSS funds..
You don’t have to necessarily exit after 3 years
The popular reason for many investors to prefer ELSS funds is that its lock-in period is the lowest at just 3 years. Comparatively, other assets like PPF and long term deposits have lock-in periods of more than 5 years. The common mistake is that most investors tend to book profits on their ELSS the moment the 3 year lock-in period is completed. Remember, the 3 year lock in period is just for your tax break. You can actually hold on to the ELSS fund as long as you want. For example, ELSS funds have an advantage over diversified equity funds in the sense that fund managers can take a longer term perspective due to the 3-year compulsory lock-in. This enhances returns in the long run. So if you are invested in an ELSS fund and are sitting on healthy profits at the end of 3 years, there is no reason for you to book profits. You can treat it just like any equity fund and hold on as long as it creates wealth.
Being bound by the Section 80C limit
A young investor recently complained that he wanted to invest in ELSS but had exhausted his Section 80C limits. The answer is not to be driven purely by the Section 80C benefits. As you move up the income ladder, the Section 80C will become increasingly inadequate. You can still look at the ELSS as a long term wealth creating instrument. The 3-year lock in will instil the long-term discipline in you and the fund manager will have the incentive to act in a more long term manner considering the lock in. Remember, ELSS funds are great investments even on a standalone basis. So don’t get obsessed and restrict yourself by the limits of Section 80C. You can look at ELSS even outside of that.
Ignoring the merits of a SIP approach to ELSS investing
The very nature of tax saving is such that most people tend to rush for investment options in the last quarter of the financial year. Ideally, you must do a SIP on an ELSS fund. On the one hand the SIP will synchronize your outflows with your monthly inflows. On the other hand, you will get the added benefit of rupee cost averaging, especially in volatile markets. There is one more advantage. The ELSS lock-in starts from the date of investment. In case of an SIP on an ELSS, the lock-in period will begin exactly from the month of investment. That gives you a 1 year advantage in making your ELSS fund more liquid.
Holding too many ELSS funds in your portfolio
This has been a standard problem with a lot of investors. Each year they tend to select the ELSS issued by a different AMC and over a few years they end up with a portfolio of ELSS funds that is spread across 7-8 AMCs. Honestly, that does not make too much sense. When you invest in an ELSS fund or any fund for that matter, you need to constantly track it. You need to track the performance, you need to benchmark with the indices, and you need to check the portfolio holdings of the ELSS and you need to ensure that the expense ratio is under control. You can closely track the portfolio of just 1-2 ELSS funds. If you hold 7-8 ELSS funds and you do not have the time and wherewithal to track these funds then the entire purpose gets defeated.
Not keeping your risk appetite and financial plan in mind
Whenever you buy an ELSS fund never lose your sense of perspective. At the end of the day, your ELSS is not just about reducing your tax burden. It has to fit two more conditions. Firstly, it must be in tune with your risk appetite. If you are over 50 then don’t just keep adding more ELSS to your portfolio. Similarly, ensure that your ELSS fits into your overall financial plan which lays out your ideal equity and debt allocation plan. If this is not taken care of then you may end up investing in an ELSS and saving tax but it may be at cross purposes with your overall financial plan.
Remember, ELSS is a great instrument to get the benefit of tax saving and wealth creation. By taking care of these common mistakes, you can surely do a better job!
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