Investing in an equity linked savings scheme or ELSS can be a smart move when it comes to diversifying your portfolio and enjoying the benefits of tax saving. With the potential for wealth creation and being eligible for deductions under 80C of the income tax act 1961,these tax saving mutual funds should be an important part of any investor’s strategy.

However, choosing the right ELSS mutual fund requires more than just evaluating your risk appetite and financial objectives. It involves a thorough analysis of the fund metrics and comprehending how they are aligned with your objectives. To ensure that your investment strategies align with your financial goals, here are some key pointers to consider while selecting an ELSS.

Read the scheme information documents carefully

Before you invest in an ELSS fund, it is important to understand its investment strategy through the documents provided by the fund house. These documents outline the fund’s objectives, past performance, associated risks, asset allocation, investment pattern, and how it is managed overall. Knowing this information can allow you to determine if the fund is aligned with your risk profile and investment objectives.

Check market cap composition

The securities and exchange board of India (SEBI) specifies that at least 80% of an ELSS fund must be invested in equity and equity-related instruments. However, there is no restriction on what percentage should be allocated to a particular type of stock such as large cap, mid cap or small cap stocks.

For example, a fund may choose to allocate 50% of its investments in large cap stocks, 25% in mid cap stocks and 25% in small cap stocks. This gives the fund manager full flexibility to decide which stocks to include in their portfolios. It is, therefore, crucial to check out how a particular ELSS fund has allocated its investments across different types of stocks so that you can gain insight into its overall risk profile and returns potential.

Research fund performance history

Investing in ELSS mutual funds requires thorough return analysis since equity investments carry market risk, and market fluctuations can impact the NAV or price of a unit. It is therefore important to understand both short-term and long-term gains associated with ELSS investing by looking at annualised returns over durations such as 1-year, 3-years, and 5-years.

Look at factors such as volatility (how much fluctuation there has been in returns) and consistency (how often the fund has met or outperformed its benchmark). This may help you determine if the fund is likely to perform according to your expectations in the future.

Compare the fund performance with its benchmark and category peers

While evaluating an ELSS scheme alone can provide you with an initial assessment of its performance, you can take your evaluation further by comparing its performance with both its category and benchmark peers.

If it outperforms its benchmark, that is an indication of a successful management approach. However, if the scheme fails to match its benchmark or category for more than a year, it could indicate underlying issues with the fund. You can gain further insight into the cause of poor performance by researching the fund online or watching interviews of fund managers.

Go for growth option

With ELSS funds, you have the flexibility to choose from dividend and growth options. Though there are certain advantages to choosing dividends, choosing a growth option fund proves to be more beneficial in the long term. This is because any dividend received serves as additional capital and gets invested back instead of getting distributed, thereby helping your investments grow with the benefit of compounding returns.

Closing thoughts

While ELSS funds offer an opportunity to invest in mutual funds while saving taxes, it is important to carefully research and evaluate them beforehand. Based on your budget, risk tolerance, and return expectations, you can choose either a lump sum or systematic investment plan (SIP) option to invest in ELSS schemes. SIP has additional benefits like rupee cost averaging, which balances the impact of market fluctuations on your portfolio and maximises your returns over time.