Do you know that the right way of investing is to diversify it? It not only minimizes the risk but also increases the returns. And if you are fascinated by this then you can include tax-savings funds in your portfolio. These funds not only help you save on taxes but also provide avenues for long-term wealth creation. Let’s explore how diversification with tax-saving funds can help today’s investors.
Why Diversifying with ELSS Funds is Important?
Tax-saving funds, primarily Equity Linked Savings Schemes (ELSS), are mutual funds that offer tax benefits under Section 80C of the Income Tax Act, 1961.
ELSS funds invest predominantly in equity markets, offering the dual benefit of tax savings and capital appreciation. The investment in equity allows for higher returns over the long term, despite short-term volatility. Diversification plays a key role in maintaining a well-rounded portfolio, offering several advantages like:
- Balance Between Growth and Safety
Debt funds are mutual funds focused on fixed-income assets such as government and corporate bonds. Unlike equity funds, which can fluctuate with market changes, debt funds offer a more predictable, stable return with lower associated risk.
- Long-term Wealth Creation
ELSS funds have shown strong performance over the years. Top-performing ELSS funds have delivered amazing returns annually over the past five years. For example, the HDFC Tax saver fund showed a YTD return of 25.74%, while the SBI Long Term Equity Fund offered a YTD return of 33.57% during the same period. This long-term growth potential and tax benefits make ELSS an attractive option.
- Shortest Lock-in Period
One significant advantage of ELSS over other tax-saving instruments is its relatively short lock-in period of three years. Comparatively, the lock-in period for PPF is 15 years, and NSC is five years.
The shorter lock-in period makes ELSS a more flexible option for investors who want quicker access to their funds without sacrificing tax benefits.
- Tax Efficiency
Long-term capital gains (LTCG) of up to Rs. 1.25 lakh per year from ELSS funds are exempt from income tax, whereas LTCG exceeding Rs. 1.25 lakh is taxed at 12.50%. Compared to other instruments like fixed deposits, where interest is taxed as per the individual’s tax slab, ELSS offers a more tax-efficient option for wealth creation.
Factors to Consider Before Investing in Tax-Saving Funds
Even though ELSS funds have various benefits, there are some factors you must weigh in before investing in them.
- Risk Tolerance
As ELSS funds are equity-based, they carry a higher level of risk compared to debt instruments. Investors should assess their risk tolerance before investing in these ELSS. Those with a long-term investment horizon and the ability to withstand short-term market fluctuations will benefit the most.
- Fund Performance
While Tax-Saving funds provide equity exposure, not all funds perform equally. It’s essential to review the fund’s past performance, expense ratio, and portfolio composition before making a decision.
Top performing ELSS funds in FY24 included the Canara Robeco Equity Tax Saver Fund and Invesco India Tax Plan, which delivered returns of 23.52% and 27.56% respectively.
- Taxation
While investing up to Rs 1.5 lakh in ELSS can save tax, it’s crucial to note that this limit includes other instruments like PPF, life insurance premiums, and NSC. Therefore, before allocating funds, investors should consider their overall Tax-Saving strategy under Section 80C.
Conclusion
Diversifying with ELSS mutual funds is essential for investors looking to strike a balance between tax savings and long-term capital appreciation. By investing in these funds, you not only reduce your tax liability but also position your portfolio for potential growth in the equity market. As always, ensure that your investment strategy aligns with your financial goals, risk tolerance, and Tax-Saving needs.
