Invest in ELSS funds if your portfolio is light on equities: Experts

Recent correction means a good chance to enter these tax-savers

The March 31 deadline for completing your tax-saving investments for financial year 2021-22 (FY22) is just a few days away. If you have not made these investments yet, you are running out of time. The sharp correction in the stock market (despite some recovery in recent days) could be a blessing for those who decide to invest in a tax-saver fund.

“The current correction provides a good entry point to investors in equity-linked savings schemes (ELSS). The net asset values (NAVs) of equity funds have dropped, so investors will get a larger number of units for their investments. Valuations have also turned more attractive,” says Anil Rego, founder and chief executive officer (CEO), Right Horizons.

Check asset allocation

ELSS invest a minimum 80 per cent in stocks. Investment up to Rs 1.5 lakh in these funds qualifies for tax deduction under Section 80C of the Income Tax Act.

ELSS does not involve a commitment to make recurring investments each year, as is the case with regular premium life insurance policies or Public Provident Fund (PPF). The only caveat is you should be able to digest the volatility that is an inherent part of investing in an equity fund.

Several other investment options qualify for tax deduction under Section 80C: Unit-linked insurance plans (Ulips), PPF, National Pension System (NPS), Five-year tax saving fixed deposits (FDs), life insurance plans, National Savings Certificate (NSC) and Senior Citizens Savings Scheme (SCSS).

Investors should first check whether they have adequate life insurance cover. If not, they should buy term insurance. If that is taken care of, they should put their money in an investment product. To decide whether to go for an equity or debt instrument, they should check their asset allocation. If they need to invest more on the equity side, then ELSS is a good option.

“You can even invest the entire limit of Rs 1.5 lakh in ELSS. If you wish to diversify, you may consider PPF, in addition to ELSS,” says Harshad Chetanwala, co-founder, MyWealthGrowth.com.

The lock-in benefit

ELSS has a three-year lock-in, which is the shortest. Other instruments that qualify for deduction under Section 80C have longer lock-ins.

The lock-in can work in investors’ favour. “Over the long term, the lock-in can help ELSS deliver better returns than open-ended funds. The latter offer full liquidity to investors and hence see heavy outflows when the market falls, and higher inflows when the market peaks. This impacts the performance of these funds as fund managers are forced to sell at low valuations (due to redemptions) and deploy funds at high valuations (due to strong inflows),” says Rego. Over the long term, ELSS is likely to offer better returns than the fixed-income options that qualify for Section 80C benefit.

Choose an appropriate fund

Look at the portfolio of an ELSS before investing. “An investor with a moderate risk appetite should select a fund that invests predominantly in large-cap stocks. One with a higher risk appetite may go for one that takes higher exposure on mid- and small-cap stocks,” says S Sridharan, founder and principal officer, Wealth Ladder Direct.

While selecting a scheme, do not pick the past year’s best performer. Instead, pick one that has been consistent over the long term, and which is still being managed by the same fund manager who was responsible for creating its track record.

“Do not withdraw money from the ELSS once the three-year lock-in ends. If it is performing well compared to its peers and other diversified-equity funds, stay invested for seven years or more. In the current market environment, ELSS could be volatile in the short term but will be rewarding over the long term,” says Chetanwala.

Avoid investing in a new ELSS scheme each year. Stick to one well-chosen scheme to avoid clutter in your portfolio. To achieve diversification, spread your non-tax saving investments across several equity funds.