How to choose a ELSS mutual fund for saving tax

Published: April 18, 2016 at 9:30 am

The start of the financial year is the best time to plan for saving tax. For those who recognise the importance of tagging tax saving instruments with long-term financial goal portfolios, there is not much to do! Linking tax planning with goals is a one-time affair and all it needs is investing and review. In this post, I would like to focus on how someone can choose an ELSS mutual fund for saving tax.

This post is more about factors to be considered before selecting a mutual fund and not about the selection process itself, which is not different from that outlined here: How to select an equity mutual fund – Making a Choice!

The starting point is this post which discusses the way Ashal Jauhari saves tax: Making the best use of section 80C for tax saving: an example.

The essence of the approach, first use applicable expenses like tuition fee for children, term life insurance, and home loan principal  (assuming one does not buy a property just to save tax!) to cover 80C.

Next, the mandatory EPF or NPS contribution is obviously part of 80C, but is also part of the debt component of our retirement portfolio.

If this exhausts the 80C, there is no need for ELSS mutual funds. If there is some room left, that amount alone can be used to invest in ELSS mutual funds, provided the investment is not touched at least until retirement (which is assumed to be decades away). If your retirement is close by, do not touch for at least 10 years.

ELSS mutual funds are being sold by advisors by comparing them to PPF. Ignore such illustrations.

A portfolio requires both fixed income and equity in a pre-planned proportion after understanding risks.

Example 1: Consider a young earner with no home loan liability , no term cover+and no child tuition fee expenses.

If the EPF contribution is say 4500 a month, 54,000 is mandatory tax saving under 80C. Say 10,000 can be invested each month, excluding the 4500 from EPF.

The total investment made towards financial freedom is 10,000+4500.

Out of this about 31% goes to EPF. About 8000 a month can be put in ELSS funds to complete the 80C rainbow.

The rest 2000 can be invested in stocks or equity mutual funds.

Example 2: Consider a married with kids earner servicing a home loan. Suppose after factoring in tax saving expenses (tuition+  principal component of EMI+ term insurance), the 80C target is reduced from 1.5 Laks to  1 lakh.

Say 8000 is the EPF contribution. So 8000 X 12 = 96000 covers most of the 80C limit. There is no need for ELSS funds. If necessary a 4000 lump sum can be put into ELSS.

Suppose the asset allocation desired is 50% equity and 50% fixed income and total investment = 17000 +8000(EPF) = 25000.

About 32% of fixed income comes from EPF. Rest 4500 can go to PPF even though there is no need for it under 80C.

The rest 50% or 12500 can be in stocks or non-ELSS equity funds.

The point is,

  • do not invest in ELSS if your intended holding period is just a few years.
  • do not invest in ELSS any more than necessary
  • do not invest in ELSS if you don’t want the tax break.
  • Invest in PFF if the asset allocation calls for it, and even if  80C deduction is not necessary.

PPF can be an integral part of your portfolio (if needed) because despite the lock-in it is a tax-free fixed income instrument. ELSS is required only as long as you have space to fill in 80C. Equity should be an integral part of a long-term portfolio, not ELSS. Therefore, the comparison between ELSS and PPF is pointless aside from a sales pitch.

Trail commission in ELSS funds  is paid upfront to a limit of 1% and this could well be a carrot for ELSS pushing. I will not be surprised if the ‘higher return’ myth About ELSS Fund Lock-in originated due to the commissions (when there no limit and entire trail was upfront).

Many people start a SIP for 3 years because the lock-in is 3 years!  I would suggest investing in a few chunks each year without starting a SIP. This gives you full control.

Do not follow the crowd! Or should I say, do not invest in Axis Long Term Equity because everyone is doing so! There is almost a 3000 Cr gap in AUM between the Axis ELSS fund and the one with next highest AUM (Reliance Tax saver)!!

If this gap is due to performance, it is only short-term performance as the fund is relatively young, if the gap is due to higher commissions then no further comment is necessary.

This kind of herding both by investors and distributors could well result in disappointment. Look for consistent performers both in terms of risk and reward that no one is talking about. It would be much calmer there!

The Axis ELSS fund fell by 8% in the last year. How many first time ELSS investors were ready for that or would be able to stomach that? Almost all ELSS funds fell during the period, but investing by looking at popularity (immediate good returns) or star rating will not last long.

If you use the Freefincal Mutual Fund Screener (Google sheets) you can shortlist many ‘quiet’ performers. There so many of them in this category that one is spoilt for choice.

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps