ELSS: Combine High Return with Tax Saving

In February you will have to submit proof of tax-saving investments in your office. Ideally, you should have started making these investments from the beginning of the financial year. But if you have not done so yet, you still have some time. One category you must definitely consider is equity linked savings schemes (ELSS), popularly known as tax-saver funds.

- Sudipta Mitu

These funds invest in equities. Most of the funds in this category are run as multicap funds, which means that they invest in large, mid- and small-cap stocks to any extent. Depending on which category is expected to do well in the future – large cap or mid-and small cap – fund managers tilt their allocation to it.

Investments in ELSS are eligible for tax deduction under Section 80C (where the limit is Rs. 1 .5 lakh per year). These funds come with a lock-in of three years, which is in fact the least among all instruments eligible for tax-saving. However, since these are equity instruments, you must have an investment horizon of at least five to seven years before you decide to invest in them. By having a longer time horizon, you can minimise your chances of sustaining losses in these volatile instruments.

Being equity instruments, they are capable of providing very good returns over a longer time frame. Over a seven-year period, the category has given an average return of 13.4 per cent, while over a 10-year period it has yielded an average return of 11.08 per cent.

However, the category now has 43 funds, so fund selection becomes crucial. Following a few simple rules of thumb will help you zero in on a good fund. First, do not go with funds that do not have a track record of at least 5-7 years. Second, do not go with a fund that has been the best performer over the past three years or five years. Instead, look for a consistent performer. This will require you to compare the calendar year returns of the fund against its benchmark. If a fund has beaten its benchmark in, say, five out of the previous seven years, it is a mark of consistency. Consistent funds tend to be less volatile, which makes it easier for investors to stick to them.