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Mistakes To Avoid While Investing In ELSS

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Publish Date: July 04th, 2019

By: Sandhya Kannan, Head – Content

An equity-linked savings scheme, or ELSS as it is commonly known, is a type of mutual fund that also helps in saving tax. An ELSS puts more than 80% of the investment amount in equities. The returns are high on an ELSS, even though it carries a fair share of risk. But with proper planning, you can make ELSS funds work in your favour. Listed below are some common mistakes you should avoid when choosing the ELSS as an investment instrument.

Related:Benefits of ELSS (Equity-linked saving schemes)

Common ELSS errors

  • Early withdrawals –

    An ELSS has a mandatory lock-in period of three years. You can redeem the funds only after this period. But it does not make much sense to withdraw your money as soon as the lock-in is over. An ELSS is a long-term investment that improves with time. You should ideally stay invested for at least five years. However, if after three years you find the fund is not performing well, you need to re-evaluate the investment. It is recommended that you weigh the pros and cons to make an error-free judgement.

  • Last-moment investments –

    As stated, ELSS mutual funds help you to save tax. This is the main reason why people invest in these funds. But for the fund to work properly and yield the ideal returns, you need to plan and research before investing your money. Do not make the common mistake of investing at the last minute, just before you file your tax returns. If you do so, you may hurriedly choose an incorrect ELSS. This can ruin your portfolio, even leading to major financial losses. You may end up making a loss that is higher than the tax money you saved! So, take your time and find the right ELSS to invest in. Thus, you will be able to save tax and make good gains from your investment as well.

  • Related:Filing Income Tax Returns - Common Mistakes

  • Frequent fund switches –

    You will obviously want your investment to fetch high returns. However, you should not switch funds frequently. This is because, even if a particular fund is not performing well right now, it may improve in the near future. The financial markets are volatile and you need to deal with the fluctuations with patience. Frequent fund transfers rob you of the compound benefits that only come over a long investment horizon. So, be patient and try not to switch the ELSS scheme too frequently.

  • Dividend plan investments –

    There are two main types of ELSS funds—dividend funds and growth funds. It is not a wise idea to invest in a dividend plan if your goal is wealth creation. This is because the overall success of an ELSS fund depends on the compound benefits earned. In a dividend fund, the returns are paid out to the investor. They are not invested back in the plan. But in a growth plan, the dividend gets added to the principal and the fund value rises. This leads to higher gains. Hence, you should look to invest in growth plans only to reap the benefit of compounding in the long run.

  • Related:What is Dividend Distribution Tax?

  • Fund category confusion –

    ELSS funds are available in different categories. You have large-cap funds, mid-cap funds, and small-cap funds. Large-cap funds have a lower risk profile than small cap funds. Small and mid-caps have greater volatility. It is thus important that you understand the risk involved. You need to assess your own risk-taking capacity before deciding to invest in a particular fund category. Unfortunately, not many people know how to invest in the appropriate fund category and not end up with losses.

  • Choosing a fund based on its current record –

    When it comes to investing in an ELSS, the keyword is consistency. You need to invest in ELSS funds that have consistently performed well. Avoid funds that boast only a brilliant run in the recent past. Rather, look for funds that have given good returns over five or 10 years. Would you bet your money on a new horse that has just won its first three races, or on a seasoned horse that has consistently finished in the top positions over the years?

  • Focusing solely on tax saving –

    Most people choose to invest in ELSS to save tax. But that should not be your only reason to make such an investment. Understand the pros and cons of buying an ELSS fund, the risks involved, and the returns available, and then make an informed choice. A common mistake is to look at the ELSS only as a tax-saving instrument and not as a vehicle for wealth creation.

  • Related:Penalties Under the Income Tax Act

  • Too many funds –

    An ELSS portfolio should be manageable. There is no reason to clutter the folio with too many funds. You may be tempted to buy a lot of ELSS funds, but remember, each fund calls for careful evaluation. You need to keep an eye on the performance and the returns to decide if you should continue with it. When you have a small number of funds, say two or three, it becomes easy to monitor them. When there are nine or 10 funds, you may not be able to monitor them with precision. So, it is important to keep a small number of funds which you can manage with ease.

  • Trying to predict the market trends –

    You may be a seasoned investor, but you still may not be able to predict the market trends accurately. The stock market has very unpredictable highs and lows that come almost always unannounced. So, do not get ELSS funds based on market predictions. Instead, study the funds and match them with your risk appetite, and then invest wisely. This will provide a good and safe platform for investment.

  • Stressing and worrying –

    Last but not least, you should not worry and get anxious. If you have invested in an ELSS fund, have faith in it and wait till the returns start coming in. Also, be realistic in your expectations. Do not expect a miracle to take place every now and then. Remain practical and let the fund work for you. Some people get so restless that they constantly check the index to see how their funds are performing! This is a mistake that can lead to unnecessary stress and even incorrect withdrawals.

As a mutual fund investor, you should stay away from these common ELSS mistakes. Understand the market trends, invest wisely, and enjoy the gains with ease. Choose your funds carefully and stay invested for as long as possible, and the returns will come your way over time.

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