So, I suppose that after having read the articles how to do section 80C tax planning and why ELSS is considered as the best tax saving option under Section 80C, you’re finally convinced that Equity Linked Savings Scheme (ELSS) is the best tax saving option under section (u/s) 80C and have decided to invest in it. However, before you invest your hard earned money in ELSS schemes you must understand how to invest in ELSS mutual funds.Follow these guidelines to select and invest in the best ELSS mutual fund:
1. Choose the right fund
Once you’ve decided to invest in ELSS, it is crucial that you select the BEST ELSS fund.
Even among the ELSS category performance differs across the various funds. At present around 30 ELSS funds are available in the market. With so many ELSS funds out there, how do you know which one to choose? Which ELSS fund is the best ?
For deciding about the best ELSS scheme to invest in, you should solely go by the long term performance. To know more details about how to invest in mutual funds, please click here. The most important factor in arriving at the final decision is to consider the past performance of the various funds in addition to the credentials of the fund house. Also remember that all ELSS funds aren’t the same. While some have small and mid-cap bias, others don’t.
The best way to choose the top rated ELSS funds is to go by the mutual fund ratings published by Value Research (Monthly), Economic Times (Quarterly MF Tracker) and Outlook Money (Annual Ratings).
As per the latest rankings by Value Research, following are the top rated funds in the ELSS category:
a) Magnum Taxgain (5 star)
b) Sundaram BNP Paribas TaxSaver (5 star)
c) Franklin India Taxshield (4 star)
d) Canara Robeco Equity Tax Saver (4 star)
e) HDFC Taxsaver (4 star)
f) Principal Personal Tax Saver (4 star)
g) Sahara Tax gain (4 star)
As long as you invest in any of the 5 or 4 star rated ELSS funds, you’ve nothing to worry about. If you would like to further filter these ELSS funds on the basis of consistent top ranking over a period of time, here are the best three
a) Canara Robeco Equity Tax Saver[1 year (1/29), 3 year (2/23), and 5 year (4/19)]
b) Sundaram BNP Paribas Taxsaver[1 year (2/29),3 year (1/23), and 5 year (2/19)]
c) Sahara Tax gain [1 year (4/29), 3 year (3/23), and 5 year (6/19)]
1/29 means that the scheme stood first out of 29 ELSS schemes and similarly 4/19 means that relative rank of the scheme was 4th out of total of 19 ELSS schemes.
Also remember to put your money in one ELSS fund or at the most two. Don’t spread it across too many funds.
UPDATE [Dec 7 2009]: For latest list of best tax saving funds see: Top ELSS for 2009-2010.
2. Minimize the risk
By now, you've selected the best ELSS fund. However, your job is not over. As you already know, the risk level of ELSS is higher compared with other tax saving instruments under section 80C.
Therefore, second consideration to be kept in mind while investing in the best ELSS is that equity markets are volatile and subject to market risks. To minimize the risk you should invest in small amounts on regular basis spread over the entire financial year rather than investing a big chunk at the end of the year. If you’re not disciplined, you can enroll for systematic investment plans (SIPs) which brings automatic discipline, time diversification and rupee cost averaging.
3. Growth vs. Dividend Option
Third, you need to choose between dividend and growth option of ELSS funds. By choosing dividend option you’ll get back part of the capital / returns every year (but at the discretion of the fund house) despite a three year lock-in period of ELSS funds. However, in my view, growth option is always better than dividend option.
Mutual fund houses have found a way to circumvent 3-year lock-in-period of ELSS schemes by declaring huge dividends usually during the last quarter (Jan to March) of the financial year to lure investors. It increases the effective tax deduction available in the first year itself.
For instance, let’s say you invest Rs 50,000 in a ELSS and soon thereafter the fund house declares a dividend and you can back Rs 10,000 just after a few days (or a few months); the tax deduction @ 33.99% (assuming you fall in the the highest tax bracket) is 16995, but due to cash back, your net investment is only Rs 40,000 and hence the effective tax deduction becomes 42.49%.
However, it shouldn’t be the criteria while choosing a particular ELSS fund over the other. So please don’t get swayed by the high dividend rates of ELSS schemes. To know, why the dividends don’t make any difference, please click here.
HAPPY INVESTING!
Also Read
1. Investing in PPF - 10 Practical Tips
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