Features of ELSS fund scheme

Following are the key attributes of ELSS mutual funds.

• • Under the Section 80C provision, ELSS funds grant tax deductions up to Rs. 1,50,000 per year.
  • The ELSS period is accompanied by a blocking period of three years, with no early departure possible.
  • You can invest any amount in ELSS. There are no restrictions, with the exceptions of different limits for individual mutual funds.
  • ELSS funds are the only tax-efficient investments that can have inflation-beating returns.
  • An investment in ELSS funds can offer you tax holiday and added-value advantages.
  • ELSS’s corpus consists primarily of stocks, although they also have exposure to fixed-income securities.

Factors to consider before investing in ELSS

It would help if you considered the following factors while choosing to invest in an ELSS mutual fund:

• • Investment perspective

If you choose to invest in an ELSS fund, your plan should include keeping the money in the scheme for at least five years. A long-term investment perspective is imperative for ELSS fund investments as they require a more extended investment period to tackle stock market volatility.

• • Returns 

You should understand that ELSS funds do not offer a guaranteed return as they are entirely dependent on the performance of the underlying securities. However, an ELSS investment period of more than five years can provide a higher return than any other tax-saving investment opportunity.

• • Locking period

As told above, the minimum locking period for the ELSS investment fund is three years. Your investment is closed for three years from the investment date, and you cannot withdraw your money before the end of this period.

Audience Asks

There is always a dilemma regarding the duration of my investments. I want to have some clarity on this.

What is important here is to try to map your investment vehicle to the time horizon. For example, my son is in the 10th standard and he has a higher education corpus outflow which will be coming in another 2-3 years’ time, so this time frame is very small to put your money in equity. So this rules out the equity option and you would want to park it into a fixed deposit or a bond fund. But if your time horizon is on the higher side, then drawing a timeline becomes essential and these are the major outflows. There cannot be one template that fits all, depending upon factors like your balance sheet, lifestyle.

There is so much information on the internet regarding investments, wealth management, financial needs, etc. and it is usually very confusing. How do you suggest that one can refine this information and make the most out of it?

I would explain it with something like cricket, everybody understands and follows cricket. So at the start of Sachin’s career he had a coach, Mr. Achrekar, who could probably guide him. Similarly, when you start playing in the investment world, it is best to have somebody as an expert, could be from family, a chartered accountant, an advisor, or a mutual fund distributor. There are a lot of products but not necessarily all these products will suit you. So avoid the noise, avoid the information overload, get an expert in the initial 5-10 years, get into simpler products that you understand, and get into a vehicle that you know how to drive and know how to fix.

In terms of capital losses, both short-term and long-term losses play an essential role in helping investors reduce taxes. Investors can use the tax-loss harvesting techniques to offset gains and pay fewer taxes on capital gains in the long and short term. 

A working example of long-term capital gains tax

For the calculation of capital gains, the government introduced the Grandfather Concept. Under it, 31st January 2018 was chosen as the base date for deciding the fair market value of equity (share price/Net asset value) for LTCGs. This meant that the net asset value (NAV) or share prices were calculated with 31st January 2018 as the reference date. 

The move was introduced to delineate the cost of acquisition of holdings concerning historical costs and fair market value (or the current price) of securities. The historical cost is related to the actual price when a transaction is executed. 

On the other hand, fair value refers to the real value of an asset in the current market. The higher of these two costs is used as the basis for calculating capital gains.

Suppose you bought shares worth Rs. 3 lakhs on 1st September 2020. After holding your shares for over one year, you decide to sell them at Rs. 5 lakhs on 31st September 2021. 

Since you have held the stock for over one year (1st September 2020 to 31st September 2021 > 1 year), the profit on this transaction will be a long-term capital gain.

On the sale, you will receive a profit of => Rs. 5 lakh – Rs. 3 lakhs = Rs. 2 lakhs

What can you identify with moving averages?

Uptrend

• • If a stock’s price value follows an upward tendency, where its recent high is higher than the previous high, and the recent low is higher than the previous low, then that stock is said to be in an uptrend.

Downtrend

• • Contrary to an uptrend, a stock is said to be in a downtrend if its price values keep fluctuating on a downwards path, meaning that its current high is lower than the previous high and its current low is lower than the previous low.

Sideways trend

• • Sideways trend occurs when the price of a security trades within a reasonably stable range without forming any distinct trends over time. In this trend, price action oscillates in a horizontal range or channel.

Significance of moving average

Examining a stock’s moving average based on current prices can help investors identify potential buy and sell signals. If the stock price is higher than the average price, it means that the trader is ready to buy the stock at a price higher than the average price. This shows that traders are optimistic about a surge in stock prices, indicating the opening for you to buy as well.

Investors should consider risk tolerance and account size when determining an appropriate position size. Even if the position size is reasonable, the investor’s loss may exceed the set risk limit if the action is below the stop-loss order. To understand what it means and how it is used, let’s take a closer look at some details of position sizing.

Position sizing and risk management

To add to the definition mentioned above, position size is the number of shares you have bought in the market that establish a balance between your psychological comfort and the risks taken on your account.

An ideal position offers an outstanding balance between your psychological and risk profile. It is essential to understand and analyse the moves that occur in the stock market. 

Equal value position sizing

In equal value position sizing, you allocate the same amount of money to all stocks. See what this means in the following example.

For example, your account size (the total amount you want to invest) is Rs. 1,00,000. You decide only to trade 20 shares in one year. In this case, you have fixed the amount to be invested in market participation by buying or selling a stock. Thus, by dividing Rs. 1,00,000 with 20, you will get the maximum allocation under equal value position sizing for each trade as Rs. 5000. 

That is why it is called the equal value position-sizing strategy. This means that in each of your market trades, only Rs. 5000 will be involved. Thus your position will be fixed at Rs. 5000 per trade.

Equal value sizing is more suitable for passive traders and investors and is easy to implement. If you are not a full-time trader and are a market participant on the side, this can be a suitable sizing method for you.

An elaborate example of the Rule of 72

Suppose you want to start a technology-based dairy business. As innovative as the idea sounds, the company will need a hefty investment and enormous operating costs. After contacting a large number of investors with your business pitch, you come across Private Investor XYZ. A high-net-worth individual, Private Investor XYZ agrees to invest Rs. 10,00,000 in your business.

However, the investment is subject to a fixed 12% return; otherwise, the investor will pull out. Private Investor XYZ wants to know how long it will take for their investment in your company to double in value.

Using the Rule of 72 to estimate how long the 12% compound interest investment will take to double their money, you can tell Private Investor XYZ that their investment will be doubled to Rs. 20,00,000 in: 72/12 = 6 => 6 years.

Thus, the rule is also a rapid tool for investors to weigh returns on investment with fixed gains over a long period.

Shortcomings

Even though the Rule of 72 is easy to calculate, it is not always the right approach. First of all, it requires a stable return. While investors can use the average stock market return or other benchmarks, past performance may not guarantee future successful performance prediction. Therefore, you should deeply research the expected returns and be careful with your estimates.

To quickly find out how long it will take to double your investment, use the fundamental Rule of 72 formula. However, if you are planning serious investments regarding retirement or education savings plans, consider using the logarithmic equation to ensure your assumptions are as accurate as possible. The critical thing to remember is that the Rule of 72 works best over long periods for a particular range of compound interest rates only.