Here are some pointers to keep in mind while selecting an ELSS in sync with your risk appetite and financial goal.
When you embark on an investment journey, you are often confronted with questions about the products that can work best for you. One instrument that probably works on both returns and tax-saving aspects is Equity-Linked Savings Schemes or ELSS. It is a diversified equity scheme that not only helps you in achieving long-term financial goals but also helps get a tax deduction benefit of up to Rs 1.5 lakh for your investments under Section 80C of the I-T Act. ELSS comes with a mandatory lock-in period of three years, which means you cannot redeem or switch during this duration. Therefore, it becomes extremely important to choose the right scheme for yourself to get the best results.
Here are five pointers to keep in mind while selecting an ELSS in sync with your risk appetite and financial goal.
Market Cap Composition Of The Portfolio
ELSS funds are like multi-cap schemes that consist of a mix of small, mid, and large-capitalization stocks. However, in the case of ELSS, fund houses have the liberty to create a higher concentration in a stock of particular capitalisation. An ELSS fund with a higher concentration in large-cap stocks is usually more stable in terms of return and risk ratio. On the other hand, ELSS having a greater concentration in mid or small-cap stocks are comparatively volatile, carry higher risk, and at the same time, have the potential to generate a greater return. Depending on your return requirement and risk appetite, you should select the appropriate mutual fund schemes that can help you achieve your financial goals on time.
Understand The Concentration Risk And Over-diversification
Different ELSS funds adopt different types of strategies for maintaining a balanced portfolio in terms of stock concentration and diversification. Some funds may invest a higher percentage of their overall portfolio in fewer stocks, whereas some may rely on a diversified portfolio and invest an almost equal portion in all the stocks in their portfolio.
For example, fund ‘ABC’ holds 100 stocks, and 5% of the total stocks in its portfolio constitute 25% of its entire corpus. Such funds are highly concentrated and carry a high volatility risk. Let us understand this better with another example. Fund ‘XYX’ holds a portfolio of 100 stocks, and the corpus is evenly distributed in all the stocks. That is a well-diversified portfolio. While a highly concentrated portfolio carries high risk, an over-diversified portfolio often dilutes the return generating capacity of the fund, and it may fail to offer a good return even during a bullish market.
When selecting an ELSS fund, focus on such schemes which are neither over-diversified nor highly concentrated. Simply, prefer a fund that has an adequately diversified portfolio.
Check The Expense Ratio Of The ELSS Fund
The expense ratio is the cost of managing the fund and related operating expenses. A higher expenses ratio brings down your return on investment to that extent. So, while investing in an ELSS fund, look for a mutual fund scheme with a lower expense ratio while the overall performance of the fund should be at par or above the category return.
Check The Basic Parameters
You should also check some crucial basic aspects such as the fund’s past performance, fund manager’s reputation etc. Past performance may not always indicate that the future of the fund will be the same, but it often helps you in estimating the capability of the fund management under different market conditions. Similarly, if the fund manager continuously performs well for a long time, and there is no significant change in the fund manager, it may indicate that such a mutual fund scheme may repeat its performance under similar market conditions.
Compare The ELSS Fund With Other Equity Funds You Have Invested
While investing in the ELSS fund, check out your existing investments in the mutual funds and avoid duplicating their portfolio structures and investment style. Choosing different types of ELSS funds can help you properly diversify and ensure a better return on investment.
If you are new to investing in a mutual fund, you may consider taking the help of a seasoned investment advisor or invest with the help of a mutual fund distributor. If you are well-versed with the mutual fund world and can select the right mutual fund scheme, you may prefer a direct investment in the mutual funds. Whatever ELSS scheme you choose, just stick to it for a longer period to create wealth.
(The writer is CEO, BankBazaar.com)