A quick introduction

Income tax today can amount to hefty sums, taking away considerably from your in-hand pay each month or year. The maximum slab rate stands at 30% today, which can go to as high as ~42%¹ when surcharge and cess are considered.

There is a saving grace though with the government making a host of income tax deductions available. From various tax saving investment options to interest on house loans to insurance premiums, donations and the like. When prudently planned out, these can help you reduce your tax outlay significantly.

One of the easiest tax saving options out there is in the form of ELSS investments.'

What are ELSS investments?

Equity Linked Savings Scheme (ELSS) is an equity oriented mutual fund that is notified and eligible for tax deduction u/s 80C of the Income tax Act (up to INR 1,50,000 annually).

It invests at least 80% of its portfolio in equity in accordance with the Equity Linked Saving Scheme, 2005. It also comes with a lock-in period of 3 years.

Why invest in ELSS?

Apart from the obvious benefit of tax saving, ELSS also gives investor capital growth potential, over the long-term since it invests predominantly in equity. This along with a lower lock-in of 3 years and tax-efficiency of returns, makes it a great choice for tax saving. In essence giving you the potential of a double bonanza – “tax deduction plus long-term wealth creation”.

Once you have decided to invest in ELSS, choosing the best ELSS fund too is important to maximise the investing benefits. The options here are plentiful with 40² ELSS schemes on offer by different AMCs, in the Indian mutual fund market today!

So how do you narrow down and choose the best ELSS fund?

Since all ELSS give you tax deduction, the key differentiating factor could be its credibility to earn returns.

Let's walk through some of the criteria you could consider when decide how to choose an ELSS fund:

• Long term consistency of performance

  One of the fundamental rules of equity fund investing is to focus on the long term and not the short term! Similarly, for ELSS funds, avoid getting short sighted with only recent fund performance.
  
  Long-term consistency of performance is key for gauging both real growth opportunity of the fund as well for appropriate risk management of your ELSS investment. Rolling returns can be a good benchmark to evaluate this. These return figures are effective to analyse returns across different periods over a long term.

• Market cap bias of the fund

  By design ELSS funds do not have any pre-determined market cap bias. So long as 80% is allocated in equity, fund managers are free to invest across market caps as per the individual fund strategy and their discretion.
  Owing to this, different ELSS funds may have varying market cap allocations – some for example may have a predominant allocation to large caps whereas others may have a reasonable allocation to mid or small caps as well.
  Matching the individual investment strategy of the ELSS to your own investing strategy is key. If you prefer to opt for predominant large caps you can choose such ELSS funds, if on the other hand you are willing to take on the higher risks of small caps for the potential for higher gain you can choose those ELSS funds accordingly.

• Investing style of the fund

  Another aspect of investing strategy is the investing style. Fund managers can opt for growth, value or blend style of investing. Once again you should match your individual investing style preference with that of the ELSS fund you choose.

• Avoid portfolio duplication

  Comparing the portfolio of ELSS funds with your existing portfolio equity investments is also important. This is necessary to ensure you opt for ELSS funds that differ from your existing equity investments to get the benefit of diversification for your portfolio.

• Fund manager expertise and fund house credibility

  The success of ELSS largely relies on its fund manager and fund house expertise. It may be wise to opt for established fund houses with a good track record. Analysing fund manager performances not only in the ELSS fund but even in other funds that they manage can be a good way to gauge their expertise in delivering returns to investors.

• Expense ratio

  Like all mutual funds, ELSS also charges an expense ratio from its investors. This is essentially to cover fund management and administration costs of the fund. The expense ratio marginally reduces returns earned by investors. Thus, choosing an ELSS which charges a relatively lower expense ratio can be favourable.

All in all, a single parameter can rarely be the conclusive or deciding factor for choosing the right ELSS for you. Considering all these factors in unison can help you choose the best ELSS fund that meets your investing and tax saving needs.

130% maximum slab rate increased by maximum surcharge rate of 37% and 4% education cess
2AMFI monthly data as on October 31, 2022

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.