How To Pick The ELSS Fund That Suits Your Risk Profile?
Are you considering to invest in tax-saving mutual funds such as Equity-Linked Saving Schemes (ELSS) prior to the end of the current financial year? These investment products offer tax benefits of up to INR 1.5 lakh per year under section 80C of the Income Tax Act, 1961. To claim these tax benefits, you must invest on or before March 31. Often, you look for the best performing ELSS plans to save tax on your hard earned money while getting decent returns on your investments as well. However, financial experts advise that you must check the investment philosophy of the funds to ensure it matches your personal needs and risk appetite.
Generally, most investors don’t account for the additional risk of investing in ELSS funds. Since all ELSS funds are natively equity funds, they have higher risks associated with them than debt instruments. Hence, before investing in equity funds, you have to analyze your own portfolio and check its equity to debt ratio, and either increase the allocation in debt instruments or decrease some of the equity ones to compensate for your ELSS investments.
How Do ELSS Investments Affect Your Risk Profile?
ELSS funds are diverse equity mutual funds that invest a majority of the accumulated corpus in equities and related securities. There are several ELSS plans offered by various asset management companies (AMCs). However, not all these fund houses invest in the same equities and other securities. Although most of these tax-saving investments maintain a diversified portfolio comprising of stocks from large-cap to small-cap. But, the amount of weightage given to each sector differs according to each fund, and hence the amount of risk that your investment is exposed to changes.
Why Do Two Different ELSS Funds Have Different Risk Profiles?
Even if two or more of the best performing tax saver mutual funds invest with the same philosophy, there is a difference. All these funds may invest in large-cap stocks but may have different companies within its portfolio. Furthermore, the funds may invest differently even if they focus on the same set of companies.
It is also possible that two funds will invest in large-cap companies but adopt a different investment strategy.
A major problem is that you may not be able to identify the various ELSS funds as large, mid, or small-cap schemes. Fund houses do not classify these as various cap funds but only as tax-saving mutual funds. Most ELSS plans are a good option for long term investments since they are focused on large-cap investments but adopt a different investment portfolio. One particular fund may be more aggressive while another may be conservative.
Large-cap funds are less risky because these invest in larger and more stable companies. On the other hand, mid-cap and small-cap funds are riskier as their exposure in smaller companies makes these more volatile.
Therefore, it is important that you invest in these tax-saving investments based on your personal risk appetite. If you have a lower risk appetite, choosing a fund that invests in large-cap companies is recommended. Similarly, if you are willing to assume higher risks, investing in funds that invest in small or mid-cap companies may deliver greater returns.
How To Determine An ELSS Fund’s Risk Profile From Its Asset Allocation?
Most other types of mutual funds classify their schemes as small, mid, or large-cap funds. However, ELSS plans are not classified under such categories making it difficult for you to make an informed decision. Such types of mutual funds may invest the corpus in any equity or related instrument. Nonetheless, the best performing tax saver mutual funds adopt a certain investment philosophy.
This difference in the investment philosophy is clearly represented in the funds’ portfolios. Generally, the average market cap of the ELSS plans is INR 36,000 crore. However, there are some funds with average market capitalization at INR 87,500 crore. Similarly, some funds have an average market cap of as low as INR 13,000 crore. This clearly shows the disparity within the investment portfolio of different ELSS funds.
A different investment philosophy implies that the risk profile of various funds varies across different plans. This is why selecting the right fund that matches your risk appetite and investment portfolio is crucial. You must base your decision on the past performance of the schemes but based on your risk profile.
If you are aggressive and want to earn higher returns and are willing to withstand volatility, opting for an ELSS plan with mid-cap stocks may be preferable. However, if you are a conservative investor with a lower risk appetite, choosing funds with large-cap exposure is recommended. You may also consider a fund with a balanced investment philosophy.
How Can Existing ELSS Fund Investors Adjust Their Risk Profile?
If you already have invested in ELSS plans, you must review your investment to determine if the fund’s philosophy matches your requirements. You must not buy a new ELSS plan each year. It is recommended you limit your ELSS exposure to one or two plans. This makes it simpler to monitor and reduces your efforts.
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