Is Your Mutual Fund Portfolio Holding Too Many Tax-Saving Schemes?

The beginning of a financial year can be considered an ideal time to engage in tax planning. However, many salaried individuals put off doing this important task until the last minute, which might have a scrambling effect at the last moment. Selecting tax-saving assets that match your risk tolerance, time horizon, and investment objectives makes much more sense than making haphazard investments. Through the several tax-saving avenues available to claim income tax benefits, a considerable sum of money can be saved if managed correctly.

Accordingly, many individuals choose Equity Linked Saving Schemes (ELSS) in order to reduce their tax burden under Section 80C of the Income Tax Act. Investments made in tax-saving mutual fund schemes or ELSS are eligible for an annual tax deduction of up to Rs 1.5 lac. Moreover, the mandatory 3-year lock-in period for these schemes is the shortest of all the tax-saving investments allowed under Section 80C.

However, most investors are generally confused about how many tax-saving mutual fund schemes or ELSS they should invest in to diversify their portfolios. In some cases, there could be multiple ELSS that they would have amassed over the years in their mutual fund portfolio. Holding too many tax-saving mutual funds in the mutual fund portfolio may make it tough to keep track of them and contradict the goal of diversification due to the overlap in the portfolios of different schemes.

You see, 'Which is the best ELSS scheme to invest in this year?' is the question raised by many investors during the tax-planning exercise for the financial year. Often, investors choose a new or top-performing ELSS every year to claim tax benefits for consecutive years or when their old tax saving scheme is not performing well for a year or two. This leads to an ELSS overload in the mutual fund portfolio. In fact, some investors eventually end up owning more than half a dozen ELSS in their portfolio. Over the years, this has led to the build-up of a plethora of tax-saving schemes in many equity mutual fund portfolios, making it necessary to consolidate them.

Given that, if you hold multiple schemes within the same category, it is likely that they would have invested in the same set of stocks with similar strategies. In this case, it will not add much value to your portfolio and instead clutter it with multiple schemes making it hard to track the performance. For instance, if you own 3-4 ELSS, it is unlikely that all of them would perform well, and you might wind up with average returns in line with the markets.

So, how many tax-saving mutual funds should ideally be in your mutual fund portfolio?

ELSS does compete with other instruments such as the Public Provident Fund, Employees' Provident Fund, ULIPs, Sukanya Samriddhi Yojana, and National Savings Certificate, which are also eligible for a deduction under Section 80C. Historically, ELSS has proven to generate significant returns in the long term than other conventional tax-saving solutions.

You are more likely to select a new ELSS and end up with an excessive number of ELSS in your portfolio if you choose an ELSS based on its recent performance, such as the last year. In most situations, chasing short-term success gets investors into difficulty; instead, a long-term approach to investing in equities is beneficial.

Nevertheless, it is wise to put money into one or two ELSS and maintain adding to it every year. As most ELSS have, on average, 60-70% of their money parked in large caps, investing in many funds within the same ELSS category would only lead to duplication and overlap. Consider selecting tax-saving funds based on long-term performance as well as additional considerations, including fund positioning and market cap bias. Risk-averse investors who might be hesitant to invest in actively managed ELSS or those who are keen on passive investing can, however, also search for passively managed ELSS.

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Should you consider consolidating ELSS in your portfolio?

If you have too many ELSS in your portfolio, then the thought of consolidation may have come to your mind multiple times. But don't make impulsive investment decisions. You may rather conduct a mutual fund portfolio review, seek professional assistance if necessary, and treat all your ELSS investments like any other equity fund. If the scheme is doing well, then let it compound money. Just because the units have passed the lock-in period does not mean that the ELSS should be liquidated immediately.

Further, identify the tax-saving funds or ELSS in your portfolio that have been underperforming the benchmark and peers for at least 3 years. If you are not comfortable with a fund that is volatile and has declined more than the benchmark during downturns, consider eliminating them. Once such underperforming ELSS are discovered, SIPs must be immediately stopped to avoid further contributions and losses.

You may redeem only those schemes that have been underperforming and consider reinvesting the sale proceeds into other worthy equity funds in your portfolio after deducting taxes. This action is crucial. When you consolidate too many minor folios by liquidating their assets, a sizable portion of your equity portfolio will be redeemed. You might miss out on the chance to compound your money if you don't reinvest the sale proceeds.

To Conclude...

You must make sure that you invest in the right tax-saving mutual funds or ELSS based on your suitability if you want to avoid having a mutual fund portfolio cluttered with too many tax-saving schemes and still gain from tax benefits and simultaneously increase your wealth. Remember, quality over quantity should be the approach. A portfolio with too many tax-saving investments may lower your tax liabilities, but the prolonged underperformance of any such ELSS may draw negative returns into your portfolio.

Now, when deciding on investment in ELSS, do not get influenced merely by past returns. You should consider evaluating the various quantitative and qualitative parameters and compare the fund's performance with its peers. This will verify the historical consistency of the tax-saving mutual fund or ELSS performance and tell you whether the fund house adheres to strict investment processes and systems.

Therefore, as you begin tax planning for the current FY2023-24, it's far more vital to make sure you are investing in the right tax-saving mutual funds and that your tax investments are in line with your financial goals. It would be a smarter approach to begin tax-saving investments in the early quarters of the financial year rather than waiting for the end of the financial year so that you get ample time to plan your investments wisely and avail maximum tax benefits.

Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.

MITALI DHOKE is a Research Analyst at PersonalFN. She is an MBA (Finance) and a post-graduate in commerce (M. Com). She focuses primarily on covering articles around mutual funds including NFOs, financial planning and fixed-income products. Mitali holds an overall experience of 4 years in the financial services industry.

She also actively contributes towards content creation for PersonalFN’s social media platforms in the endeavour to educate investors and enhance their financial knowledge.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision.