Equity Linked Saving Schemes offer a good option for wealth creation. This article explains why you should explore them this year.
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Your financial goals for the year 2022 encompass creating wealth for the future with the right investments. You should check out tax saving ELSS funds for this purpose.
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What is an ELSS?
It is a mutual fund often used for tax saving and wealth creation. It invests primarily in equity securities. It has a three-year lock in period, but you can choose to stay invested in it for long to create wealth in line with your investment objectives.
Why invest in ELSS in 2022?
The market and economy are still in a state of flux, with the novel Coronavirus showing no signs of letting up. It caused two deadly waves in the years 2020 and 2021, causing deaths and infection in the millions. Meanwhile, it caused entire economies to collapse and scores of businesses to fold permanently, reducing employment numbers and creating an economic disaster the likes of which have not been seen in recent years.
However, it is time to bounce back from these events and hearteningly, the markets are beginning to perform better. Accordingly, it is time to pick instruments such as the ELSS to save money and create stability for the future. Here’s why the ELSS is one of the most important financial options for the year 2022:
- High diversification: The fund invests across companies with varying degrees of market capitalisation. This diversifies the fund immensely, while also offering a rebalance of the portfolio as per market changes.
- Get tax benefits and save money: Unlike regular mutual funds, the ELSS offers tax deductions up to Rs 1.5 lakh per year under Sec 80C of the Income Tax Act, 1961. The maturity amount earned on the ELSS (if it is below Rs 1 lakh) is exempted from taxation at the end of three years, which is the lock-in period for the fund. The tax saving ELSS thus saves money every year.
- Excellent short-term option: The fund has the shortest lock-in period among all mutual funds in India. You can take the fund’s earnings at the end of three years, or continue the investment for a longer period for more gains.
- Excellent long-term gains: However, staying invested in the fund for a longer time frame yields better returns. The longer time frame insulates your money against market fluctuations. The ELSS has been seen to generate good long-term income (over 80% of the money is invested in equities) if you stay invested in it for longer. Despite market fluctuations, equities usually grow exponentially over a longer time frame, thus generating excellent returns for wealth creation objectives. One may easily create a Rs 1 crore corpus through strategic investment in the ELSS.
How to invest in an ELSS for future wealth
Now that you are about to invest in an ELSS, you should pay attention to these factors:
* Check the basics: When researching the preferred fund, start by checking its past performance and the fund manager’s market reputation and skill. If the manager has performed consistently well for years without significant changes to investment strategy, it often means that the fund may continue to perform well provided market conditions remain unchanged.
* Fund market cap composition: The fund house can choose between two strategies when investing in the ELSS: either choose a higher concentration of stock with a large cap capitalisation, or choose a bunch of mid-cap and small-cap stocks. Doing the former ensures that the investment is more stable and lower on risk. But doing the latter increases the risk ratio while generating higher, faster returns. The appropriate selection must be made depending on your desired outcomes and risk appetite.
* Check the fund’s expense ratio: The term ‘expense ratio’ refers to the fund management costs. The higher the expense ratio, the more it cuts into your eventual returns. Look for a scheme that has a lower expense ratio without impacting performance.
* Compare the fund with other equity funds in your portfolio: An easy mistake to make, especially for novice investors, is to avoid duplicating the portfolio structure and investment patterns of the past. This can be eliminated by checking your existing investments in equity funds and thus, a different ELSS fund to aid diversification instead of duplicating current investments.
* Avoid diversifying too much: Diversification in your portfolio ensures that risk is lowered while returns are guaranteed over a period of time. However, over-diversification can result in high volatility. An example of this is high concentration in certain stocks. Always approach the investment with the aim to evenly distribute the corpus in all the stocks – this is proper diversification. Check the fund for its diversification ratio before you invest.
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