Looking for tax-saving options? Opt for ELSS

Investors must, however, be prepared for volatility in ELSS, cautions Sanjay Kumar Singh.

With just days left for the financial year to end, investors who have not made their tax-saving investments need to do so at the earliest.

One product they should consider is equity-linked savings scheme (ELSS), also known as taxsaver funds.

Since ELSS is often the first equity fund category that young investors invest in, they should choose their fund carefully, so that their initial experience in equity investing is good and they get hooked to this asset class for the long term.

ELSS is eligible for tax deduction under Section 80C up to Rs 1.5 lakh.

In the Budget, Unit Linked Insurance Plans (ULIPs), whose annual premiums exceed Rs 2.5 lakh, were made taxable on maturity at 10 per cent.

Equity funds (including ELSS) are taxable at the same rate on long-term capital gains of above Rs 1 lakh.

This measure brought in parity between the taxation of ELSS and high-premium ULIPs (which also qualify for Section 80C benefit).

Lock-in prevents tinkering

At three years, the lock-in in ELSS is the least among all the instruments eligible for Section 80C tax deduction.

Experts regard the lock-in as a positive feature.

"It forces investors to stay invested despite volatility or short periods of underperformance, and so they often end up with good returns," says Gautam Kalia, head-investment solutions, Sharekhan by BNP Paribas.

According to Kalia, the lock-in also means fund managers don't have to keep a large portion of the portfolio in cash to meet redemption pressure, and can take longer-term investment calls.

Investors must, however, be prepared for volatility in ELSS.

Should you invest at current levels?

If, in her/his asset allocation, an investor is already overweight on equities, s/he may opt for a debt product to meet her/his tax-saving goals.

But if s/he is underweight, s/he should invest in ELSS.

Equity market valuations are on the higher side currently.

"But one doesn't know how long this liquidity-fuelled rally will continue.

The markets could move further up, so it is better to invest," says Kalia.

Corporate earnings are poised for a recovery.

"Earnings growth could be strong over the next five-seven years, in which case investors could still make sound returns from ELSS," says Arun Kumar, head of research, FundsIndia.com.

Go with a tested fund

Select a fund that has at least a 10-year track record.

Its fund manager, too, should have a sound track record of at least 10 years, managing this or another fund.

Give greater weight to longer-term track record.

Since switching is difficult in ELSS, Kumar suggests going with a larger fund house that has a stable fund management team.

Many existing investors may have selected a fund based on past performance or star rating, and its performance may have dipped after they invested.

This happens because fund managers have different investment styles -- quality, value, or growth at reasonable price.

The market does not support one style of investing all the time.

If someone invested based on recent performance, he could be entering a fund that has already enjoyed a hot streak and is ready to cool off.

"Go with two or three strong fund managers who have different investment styles to tackle this issue," says Kumar.

A fund's style box will tell you about its fund manager's style.

Stay invested for seven years, so that a period of underperformance is compensated for by a spell of strong performance.

Prefer funds that have a lower expense ratio.

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Feature Presentation: Aslam Hunani/Rediff.com