ELSS Mutual Fund – 3 Mistakes to Avoid

Of late, ELSS (Equity Linked Savings Schemes) or “Tax Saving Mutual Funds” have gained tremendous popularity. More and more investors are starting to believe that for saving taxes, ELSS Mutual Funds Sahi Hai!

And why not? As a category, Tax Saving Mutual Funds have grown investor wealth at nearly 18% per annum between 2013 and 2020 – nearly twice as fast as traditional choices such as NSC and PPF, and almost three times faster than traditional Life Insurance. 

Their shorter lock-in period of three years has added to their allure.

All the obvious advantages of ELSS Funds as an 80(C) instrument notwithstanding, they possess a few all too common pitfalls too. Here are three of them that you must avoid at all costs.

1.Not understanding the risks

Unfortunately, there are no free lunches in the investment world. Increased return potential will invariably be accompanied by an increased risk of capital erosion. Being equity-linked, ELSS funds are high risk in nature – during the crash of 2008 & Covid’19 crisis many ELSS funds fell to nearly half their value!

As an investor, you would do well to understand the risks associated with ELSS funds before taking a final decision.

If you’re very risk-averse, you may want to consider splitting your tax-saving amount between ELSS funds and other lower-risk instruments such as PPF or Tax Saving FD’s – lower returns notwithstanding.

Respecting your unique investment preferences and risk tolerance levels and critical for long-term investing success.

2.The Investing in one shot

A common ELSS Mutual Fund related mistake – is to hold back until the last moment and make a lump sum investment into a tax saving mutual fund and the very end of the fiscal year.

While this approach would benefit you if you luckily end up catching a market bottom; it could work against you if you end up investing at a market peak (neither of which can be predicted).

A much smarter approach would be to start a Mutual Fund SIP (Systematic Investment Plan) in an ELSS Mutual Fund at the start of the financial year, after computing your projected deficit for the year.

For instance – start a monthly SIP of Rs. 12,500 in 12 months will make 1,50,000. In doing so, you’ll be benefiting from a mechanism called “Rupee Cost Averaging” which greatly mitigates the risks associated with the stock markets.

In the long run, your returns will be a whole lot smoother and less volatile, and you’ll worry about your investments much less.

3.The Fixating on the 3-year lock-in

By fixating on the three-year lock-in, many investors harbor the mistaken belief that three years is a sufficient time horizon to invest in ELSS Mutual Funds. In reality, a time horizon of five to seven years is a lot more appropriate, since a Tax Saving Mutual Funds is essentially a 100% equity-oriented investment.

In situations where lump sum investments are made when market valuations are already stretched (such as today’s scenario), it is quite likely that ELSS returns could be flat to negative over a three-year period, with a couple of rough-rides thrown in during the course too.

In such situations, investors need to be willing to extend their time horizons by a further three to four years (beyond the mandated three-year lock-in) to really reap rewards. While you can derive a degree of comfort that the mandated lock-in will finish within 36 months, you need to mentally commit yourself to a longer investment horizon if you’re opting for a Tax Saving Mutual Fund.

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