Investing in ELSS Tax Saving Mutual Funds - Avoid These Mistakes

Equity Linked Saving Schemes popularly known as ELSSes have off late become one of the most preferred ways of saving income tax under section 80C. The reasons are quite simple and which are favorite to all inventors. This fund comes with least lockin period of 3 years which is lowest among all the tax saving options. On top of that this fund category is known to have generated substantially high return historically. However even a very good plan many times does not work if not executed properly. Similarly there are some very common mistakes which people do and these are very specific to ELSS. These mistakes can potentially harm your investment in big way. Being aware of these mistakes can help you avoid and even rectify them.

1 Considering it same as other tax saving option under section 80C

The first mistake that people do is to consider ELSS investment similar to other section 80C investment options. We come across many people who consider it to be similar to other options like PPF, NSC and Sukanya Samriddhi Yojna. However, the truth is that ELSS has one of the highest levels of risk among all the section 80C investment options. This is an equity investment and carries the risk of volatility and market correction. So you should be aware about this risk before investing. However, if you still decide to invest then you should be prepared to face the corresponding risk also. If you do not want to take any risk then it’s better for you to stick with fixed income products which can give you assured return..

2 Last minute bulk investment

The second big mistake, which most of people do is to invest in last minute. It is an irony that more than half of the ELSS investments are done in the last quarter of financial year from the month of January to March every year. March alone, which is last month of a financial year, contributes more than 20% of all ELSS investment. This is mostly done to utilize the last minute window of tax saving under section 80C.

Bulk investment always comes with the risk of timing the market. It will be sheer luck that you find the timing right but it’s not a method to depend upon. There is good chance that you will end up with wrong timing. It has largely been the case as there were many better investment opportunities than the last 3 months when people typically invest in ELSS. What if the market was at short term peak when you entered, and soon after your investment, it gets corrected? Your loss would be significant and it will take quite a long time for your investment to recover.

SIP or a systematic investment plan is a better way for an average investor to enter the market at regular intervals so that you incur an average cost. Whenever market is high your SIP installments buy lesser units and whenever the market falls it buys more number of units with the same SIP installment amount. So on average it helps you mitigate the risk of timing the market. From the beginning of next financial year you should make sure that you start an SIP quite early.

3 Each year investing into a new ELSSes

The third big common mistake which many people do is to buy too many schemes. This happens because they do bulk investment at the end of the year as said earlier. They remain idle during initial 9 months. Not only this, to use their entire limit of section 80C they divide their bulk investments into 2 to 3 new schemes based on last minute recommendations. As they do it every year, so typically in 5 year time they end up with more than 10 ELSS schemes. This creates the problem of over diversification. Rather than investing and sticking to some better performing plans their investment is scattered all over the places. As a result rather than having high return they end up having an average return. High number of schemes also makes it difficult for you to monitor and review all your investment timely and appropriately. Therefore it would be much better if you can identify one or two right ELSSes and continue with an SIP for longer period so that it takes care of your each year tax saving investment requirement.

4 Going for dividend option

The fourth common mistake which most of the people do is to select the dividend option while investing in ELSSes. This happens because many people try to circumvent the lock-in period. What they want is, while their money is locked in, they can still get some liquidity during the lock in period through the dividend option. Mutual funds do not pay dividends from their own pocket. But they pay dividends only from your money. The money that you get as dividend loses the opportunity to grow with the same return which your locked-in money grows. As a result the maturity amount that you get becomes less attractive. If you go for dividend reinvestment option then it would cause another problem. Each time a dividend is reinvested it gets locked in for next 3 years. Even after long investment you would not be able to withdraw the entire amount at once. It’s better to go for growth option in which your gains keep growing with the rest of the invested money.

5 All ELSS fund are not the same

The fifth common mistake that people do is to consider all ELSS funds as same because all offer the same tax benefit in terms of equity investment and have same lock-in period. However, just because these funds offer similar tax benefit does not necessarily mean that they are same especially in terms of return and risk metrics. Just like other normal equity funds ELSSes may differ widely on account of the kind equities they invest into. Some may be large cap focused with lesser risk some may be midcap oriented with higher risk and other may be small cap focused with highest risk while some may also be multicap focused with moderate risk. Some may focus on another theme of their choice with divergent risk factor. So going just by their return and selecting funds for investment may not be the right way. You need to understand their investment objective and then identify a right fund which matches your investment objective and your risk appetite.

6 Redeeming all funds just after the lock-in

The sixth mistake that people do is to redeem their ELSS investment just after 3 years of investment when the lock-in period gets over. Was your purpose just to save taxes and not to get good return or fulfill a life goal? What if the market has seen some correction or has remained stagnant. You will miss the next surge whenever that will happen. Equity investment is ideal when you remain invested for longer period like starting from 5-7 years to help you accrue a substantial sum of money and meet a major life goal.

ELSS is very good investment option which can help you meet most important financial goals of your life but only when you avoid doing these very common mistakes.