Diversification of your mutual fund portfolio is crucial but over-diversification can lead to futile results. Read below to find out the ideal number of ELSS funds you should invest in, and why…
This is the tax-saving season. Thanks to the internet, most people are now aware of the tax-saving opportunities under various sections of the Income Tax Act. Speaking of this, many people invest in ELSS (Equity Linked Saving Schemes) to save a good amount of tax under section 80C. However, when it comes to the more serious questions, like ‘how many ELSS funds you should invest in?’ or ‘is it really necessary for you to diversify your mutual fund portfolio?’, majority of people get confused.
Fret not. If you too have been struggling with these questions, we have got you covered. Without further ado, let’s explore the matter:
What is diversification? And, is it really necessary?
Diversification is one of the most basic concepts in investment. Your purpose, by diversifying, is to attain variety. It is the simplest strategy to manage risk. When you diversify your portfolio you lower the overall volatility of your portfolio. This is because all industries, stock markets and asset categories perform at different rates. So, having a variety of funds in your portfolio will help you maintain a balance and safeguard your money amid the cyclic rise and fall of various markets.
How many ELSS funds should you have in your portfolio to save tax?
If you are investing in ELSS funds for the purpose of saving tax, 1-2 or maximum 3 schemes are fine. This is because these tax-saving mutual funds qualify for a maximum tax deduction of up to INR 1.5 lakh under section 80C of ITA. In addition to this, we advise you to invest in these schemes with an investment horizon of 5 to 7 years in mind in order to reap the maximum benefit.
If you invest in more schemes at once, it leads to over-diversification. And, in this case, more does not necessarily equate beneficial. It may, in fact, ruin your portfolio by making it difficult to manage.
What exactly happens if you over-diversify?
When you invest in too many schemes, it nullifies the purpose of diversification. Since most of the schemes contain similar stocks, you might end up investing in and owning a big chunk of the stock market. This will further result in overlapping of different schemes. Since the same type of stocks will yield you the same results, it is unlikely to get any additional profits in such a scenario. Instead, the looming task to manage several stocks at once creates a burden and you will eventually find it difficult to keep proper track of your portfolio.
What can you do if you have an over-diversified portfolio?
The most common reason for over-diversification is the desire to save more tax. For instance, many people invest in 1 or 2 schemes during a particular financial year to save tax and then repeat the same in the next consecutive year. This leads to a pile of funds over the years.
Trying to recover from an underperforming scheme is yet another reason why many people invest in more schemes. However, as explained above, since most schemes contain similar stocks, such a step is more likely to hurt your portfolio than correct it. So, what should you do in case you have too many ELSS funds in your mutual fund portfolio?
Our experts say that you have two options to correct this over-diversification:
- You can review your portfolio and move those not performing well into diversified equity, debt funds or other schemes as per your risk profile. However, since the lock-in period for ELSS funds is of 3 years, this can be done only after 3 years.
- You can redeem your least performing funds after the lock-in period is over and re-invest them into better-suited ELSS funds with the help of a financial advisor. This will help you in claiming tax-benefits as well as in creating a better portfolio to meet your long term financial goals.
Lastly, remember, too much of anything is bad. The same is the case for ELSS funds in your portfolio. So, it is best to invest in 1 or 2 schemes only. And, in case you have invested in multiple ELSS funds over the years for the purpose of saving tax, our advice is to move out of the least performing schemes. For any further clarification or queries, contact us at firstname.lastname@example.org