How Do ELSS Investments Affect Your Asset Allocation?
ELSS fund have always been a good option for tax saving purposes with the Rs. 1.5 lakh in tax deductions, and tax free returns they offered. But, before you start investing in ELSS, one thing you should keep in mind is your portfolio’s asset allocation. Since ELSS funds are basically equity funds, it can greatly skew you portfolio’s exposure to equity.
You should identify the asset allocation of your ELSS funds and accordingly either reduce your equity exposure in other existing investments, or buying more debt instruments to keep your portfolio balanced.
What Is The Asset Allocation For ELSS Funds?
Asset allocation is the procedure whereby you divi
de your total investments into different categories such as equity, debt, and cash. The primary objective is to reduce the volatility while maximizing your potential return on investments. Investing in different asset classes ensures that you achieve enough diversification in your entire portfolio so that it is not affected due to movement in just one of the market. Asset allocation varies from one individual to another. Some important factors that determine asset allocation are age, risk profile, financial goals, and your lifestyle.
Since ELSS funds are just equity funds, blindly investing in them can negatively affect your portfolio balance. To ensure that your ELSS investments don’t affect your portfolio asset allocation, you need to change either reduce investments in other equity products, or you can make additional investments in debt instruments.
What Are The Different Types Of Asset Allocation Methods?
The primary objective of asset allocation is to achieve optimal diversification. Portfolio building is an art as well as a science and depends on your risk appetite. Here are three common methods used for asset allocation:
- Strategic asset allocation
- Dynamic allocation of assets
- Time matrix allocation
Now let’s look at these three asset allocation strategies in greater details:
1. Strategic asset allocation
The portfolio depends on your risk profile and investment period. It is important you stick to your plan until your financial goals are achieved. Once you complete allocating your assets, it is recommended you rebalance the same at least once a year. This ensures lower risks while reducing your efforts and management fees.
2. Dynamic allocation of assets
The emphasis given on a particular asset class depends on market dynamics. Under this method, funds are more actively managed; thereby resulting in higher management costs. In addition, returns are more volatile as these depend on ensuring several factors are right simultaneously. You must review and rebalance the portfolio at least once in a quarter to make the entire task less cumbersome.
3. Time matrix allocation
Based on your objectives, risk profile, and surplus fund availability, you may build an aggressive, balanced, or conservative portfolio. Generally, as you grow older, your responsibilities increase and your risk appetite reduces. Once your important life goals are achieved, you enjoy more flexibility. In comparison, if your goals are approaching, adopting a conservative approach may be beneficial.
How To Choose ELSS Funds Based On Your Asset Allocation?
A popular investment product because of its tax saving is the Equity-Linked Saving Scheme, more commonly known as ELSS funds. It enjoys the EEE (exempt, exempt, exempt) status, which means the principal, dividends, and maturity proceeds are all exempt from taxes. However, it is important that you do not ignore the other aspects when you invest in ELSS funds. Here are four mistakes you must not make:
- Don’t judge ELSS funds based only on their short-term performance
- Don’t redeem your ELSS funds immediately after the lock-in period
- Don’t invest in multiple ELSS schemes
- Don’t invest in ELSS funds only for their tax-saving benefits
Let us expand these points for more clarity:
1. Don’t judge ELSS funds based only on their short-term performance
You must never make an investment decision based on the short-term performance of ELSS plans. It is important to choose tax-saving investments that deliver consistent returns for at least five years. Furthermore, you must not only consider the returns but also ensure the fund philosophy matches your requirements and objectives.
2. Don’t redeem your ELSS funds immediately after the lock-in period
When you invest in ELSS funds, you must remain invested for at least three years. If your chosen scheme continues to perform as per your expectations even after the lock-in period, you must not redeem your investments. In addition, such funds invest a majority of the corpus in equities and to maximize your returns, investing for five to seven years is recommended.
3. Don’t invest in multiple ELSS schemes
You may choose new ELSS funds each year to reduce your tax liability. However, accumulating multiple schemes makes it difficult to manage your portfolio over the long term. Too many ELSS plans will result in over-diversification, which makes monitoring more difficult.
4. Don’t invest in ELSS funds only for their tax-saving benefits
ELSS plans offer tax benefits of up to INR 1.5 lakh per annum under section 80C of the Income Tax Act. However, you must not invest in these only because these are tax- saving investments. Remember that these are diversified equity funds with an inherent risk. Therefore, consider your risk profile and investment philosophy before making your decision.
It is advisable to use an advanced tool like the ARQ investment engine offered by the Angel Bee app to evaluate different ELSS plans and make a wise investment decision. ARQ uses advanced algorithms and quants to offer customized investment recommendations. What makes ARQ stand out is that in this technology-driven tool, investment recommendations are offered by machines without any human intervention. Download the Angel Bee app today and get customized investment suggestions on your smartphone.