Multi-cap ELSS best for first-time investors

With just over five months to go in the current financial year, it's time to ensure that your tax-savings investments are on track. The habit of investing at the fag end of the financial year puts a lot of financial burden in the form of having to generate a lumpsum amount. Hence, by strategising your tax-savings investments and by investing systematically in options that are potentially better, you can save taxes more efficiently and make them less taxing for yourselves.

A good tax planning starts with calculating your tax liability. Considering the mandatory lock-in period for tax-saving options, the next step should be to align them to your long-term investment goals so that these investments can contribute in a meaningful manner towards achieving them.

Don't make the mistake of either investing in any eligible option that comes your way or relying mainly on traditional options like five-year bank fixed deposit, investment-cum-insurance products, National Savings Certificate and Public Provident Fund as that can undermine the role these investments can play in your portfolio.

Although these options provide safety of capital, low returns, that is, both pre- and post-tax, makes you compromise on your ability to generate large enough corpus to achieve your long-term goals.

Mutual funds have an important role to play here. Equity Linked Savings Schemes (ELSS) of mutual funds qualify for tax exemption under section 80C of the Income Tax Act. An ELSS is perhaps the best way to achieve the dual objectives of benefiting from the growth in the stock market as well as save taxes while doing so.

As a product category, ELSS has given handsome returns over the years. Of course, being equity oriented, these schemes carry the attendant risks that are associated with any equity investment. While, the past performance alone should not be the sole criteria for making an investment, the fact remains that equities have the potential to provide better returns compared to other instruments in the long run. Besides, a three years lock-in period ensures that one of the major risks faced by new as well as existing investors, that is, volatility over the short term is handled efficiently.

Another notable feature is the tax efficiency of returns earned through them, especially if you are liable to pay taxes at higher tax rates. As per current tax laws, long-term capital gains (LTCG) as well as dividend distribution are taxed at a flat rate of ten percent. The difference being that while tax on LTCG is paid by you, Divident Distribution Tax is paid by mutual funds before distributing dividend.

ELSS are governed by guidelines issued by the government. These guidelines have specified the minimum amount to be Rs 500 and thereafter in multiples of Rs 500. Being open-ended, ELSS also allow investors to invest systematically. As regards the investment pattern, these schemes have to invest at least 80% of the corpus in equity and equity related instruments. However, fund houses can decide their own investment strategies. Therefore, you must analyse the portfolio composition while selecting a tax-savings scheme.

For a first-time investor, an ideal ELSS will be the one that has a multi-cap portfolio, with a bias towards large-cap stocks. Remember, while the past performance can't be ignored, it is equally important to analyse the risk taken by the fund manger in achieving those returns.

If the portfolio composition and the investment philosophy of a fund with an impressive performance track record takes you beyond your risk-taking capacity, you would be better off investing in an ELSS that has a well-balanced portfolio as well as a consistent performance track record.

The writer is CEO, Wiseinvest Advisors