It is that time of the year again when investors start thinking about taxes and tax-saving investments. ELSS mutual funds which provide exposure to equity markets while allowing investors to get tax benefits have become increasingly popular especially among young people. However, while the tax saving aspect of ELSS gets talked about a lot, the dangers of mis-selling often get ignored. Read below to find out why you should be especially careful of the ELSS advice that you get.
What are ELSS funds?
A brief recap of what are ELSS funds: These are diversified equity mutual funds (>65% investment in equities). Any amount invested in ELSS funds, up to a limit of 1.5 lakhs per year, is tax-deductible under Section 80C. Capital gains made on the investment are also tax-free. This means that by investing 1.5 lakh in ELSS funds, investors can enjoy a tax benefit of up to 45,000 Rs. However, to enjoy these benefits, investors have to lock in funds for at least 3 years.
Selecting the right ELSS fund is crucial
While the tax incentive is definitely a plus and the focus of attention, investors should not ignore the importance of selecting the right ELSS fund. Any money invested in these funds stays there for 3 years and hence a wrong choice can be especially costly compared to other mutual fund investments. However just like the 3-year lock-in period makes the choice of ELSS fund crucial for investors, it also increases the chances of mis-selling i.e. an agent recommending an ELSS fund which may not be in the investor’s best interest.
Commissions are high for ELSS funds and can be very different across fund houses
Due to the lock-in period of 3 years, the probability of investor switching before 3 years is quite low. Hence it is possible for mutual fund houses to offer significant upfront commissions of up to 4- 5% on the investment as opposed to 0.5-1% for normal funds. Also, there is a wide variation in the upfront commissions offered by different fund houses on ELSS funds starting from as low as 2% to all the way up to 4-5%. This increases the probability that an agent/”advisor” will try to sell an investor the highest commission fund rather than a fund which is an investor’s best interest. As a result, investors should be particularly careful and make thorough inquiries into commissions before accepting any “free” advice on ELSS funds.
Invest in direct ELSS funds
A second point that arises is whether investors should be paying any commissions at all. The average expense ratio of the regular plans of ELSS funds is 2.5% p.a. Direct plans, which do not include distributor commissions, have an average expense ratio of 1.7% p.a.
The big question that investors need to ask themselves is whether the service of recommending an ELSS fund is valuable enough to warrant paying an extra 2.4% (0.8 % over3 years) of your investment to your commissions-based advisor. Or would they be better off going direct and choosing the fund on your own or with the help of an unbiased, fee-based advisor?
ORO enables investors to invest in direct ELSS funds. To check our top 2 picks in ELSS funds and buy 0-commission plans click here.