How to choose the right tax-saving mutual fund schemes?
We are already in the last quarter of the financial year, and most of the employers will be pushing for the proofs of your tax-saving investments. With the increasing awareness of mutual funds as an investment option, Equity Linked Savings Scheme (ELSS) funds are also emerging as the preferred option for tax savings. Such funds need to have at least 65% of the portfolio invested in equity shares, and equity-related securities and are further subject to a lock-in period of 3 years. Investors are eligible for tax benefit under Section 80C of the Income Tax Act for the investment made in ELSS funds, subject to a maximum of Rs. 1.50 lakhs during a financial year.
However, even under the ELSS universe, the investors have many mutual fund schemes being offered by different fund houses. The investors may differentiate between different funds based on various parameters. Here is a brief guide on how to choose the right tax saving mutual fund scheme:
This is often the sole criterion for many investors, but instead, it should only be one of the parameters. Further, to eliminate any short-term bias, you must compare only the long-term investment performance of the fund. This assumes further importance for ELSS funds as equities tend to be volatile over a short-term, and you must stay invested for at least three years with the fund due to lock-in requirement.
In mutual funds, the investment decisions are taken by professional fund managers. As such, the investment performance must also be gauged by the continuity of the fund management team. In case the fund managers have not been with the fund for a relatively long period, the long-term performance of the fund loses its relevance for comparison purposes. This is because the investing strategies may change due to change in the fund managers leading to a modified risk-reward profile for the scheme.
Size of the fund
The size of the fund also plays an important role, especially in terms of the stability of the portfolio. The investment performance of a small fund may be skewed due to a single investment decision owing to its low base, while a large fund needs to have a sustained history of winners to generate consistent long-term returns. Further, a larger fund will have better shock absorption capacity and better liquidity, thus protecting the investors from any significant risks.
Ability to restrict downside
Considering the current economic scenario and market volatility, the investors may try to prioritise the safety of capital as against ‘return on capital’. As such, they may prefer funds with a proven record of limiting the downside along with lower volatility. The investors may compare the investment performance of different funds across the market cycles, instead of fixed periods. The standard deviation of a fund can also throw some light on the portfolio volatility, and the investors may check the standard deviation from the fund factsheet, available every month on the website of the fund house.
The investors can also check the portfolio composition of different funds through the fund factsheet. Careful screening of the portfolio may throw some insights on the fund’s investment strategy, on whether it follows high beta stocks, whether it relies more on large caps or mid-caps etc. The investors must also review the maximum investment exposure to specific companies, groups, sectors, etc. which can lead to the concentration risk for the investors. Having a diversified portfolio can help the investors to mitigate investment risks, especially the concentration risk.
The process of reviewing and choosing an ELSS fund may not be different from that of selecting a regular mutual fund scheme. However, the presence of a lock-in period makes it more important for the investors to make a good decision right at the time of investment, as any mistake cannot be otherwise rectified before the expiry of the 3-year lock-in period. Choose wisely, invest safely.