Three Common ELSS Related Mistakes To Avoid

Over the past five years, ELSS (Equity Linked Savings Schemes) have gained popularity amongst the investing masses. And why not? As a category, they've grown investor wealth at over 15 per cent per annum between 2012 and 2017 - nearly twice as fast as traditional choices such as NSC and PPF, and almost three times faster than traditional Life Insurance. Their shorter lock-in period of three years has added to their allure.

All the obvious advantages of ELSS Funds as an 80(C) instrument notwithstanding, they possess a few all too common pitfalls too. With under 40 days left in this fiscal, you may want to acquaint yourself with them before you make the decision to jump in with both feet.

Not understanding their risks properly
One of the ultimate truths of the investing world is that there are well and truly no free lunches. Increased return potential will invariably be accompanied with increased risk of capital erosion. Being equity linked, ELSS funds are high risk in nature - during the severe crash of 2008, many ELSS fund NAV's fell between 60 and 70 per cent!

The mandatory lock in period of three years also allows ELSS Fund Managers more flexibility with respect to picking stocks. Armed with this flexibility - and with the promise of a more predictable degree of redemption pressure, ELSS Fund Managers tend to concentrate their portfolios into 'value' picks that may not move in sync with the broader market, but which have the potential to become multi-baggers in the longer term. This usually results in long term outperformance, but at the cost of a few short-term shocks!

As an investor, you would do well to understand the risks associated with ELSS funds before taking a final decision. If you're very risk averse, you may want to consider splitting your tax saving amount between ELSS funds and other lower risk instruments such as PPF or Tax Saving FD's - lower returns notwithstanding. Respecting your unique investment preferences and risk tolerance levels and critical for long-term investing success.

Fixating on the 3-year lock in
By fixating on the three-year lock-in, many investors harbor the mistaken belief that three years is a sufficient time horizon to invest into ELSS funds. A time horizon of five to seven years is a lot more appropriate.

In situations where lump sum investments are made when market valuations are already stretched, it is quite likely that ELSS returns could be flat to negative over a three-year period, with a couple of rough rides thrown in during the course too.

In such situations, investors need to be willing to extend their time horizons by a further three to four years (beyond the mandated three-year lock-in) to really reap rewards. Stock markets are cyclical in nature, and phases of capitulation will invariably be followed by phases of rapid growth - only the timing is uncertain, their occurrence is almost a given. Redeeming ELSS money with flat to negative returns 'just because three years are up' would be an incorrect course of action. While you can derive a degree of comfort that the mandated lock-in will finish within 36 months, you need to mentally commit yourself to longer investment horizon if you're opting for an ELSS; as is the case with any equity oriented investment.

Going in "all at once"
The third - and arguably most common ELSS related mistake - is the habit of waiting until the penultimate moment and making a lump sum investment into an ELSS in the last week or fortnight of the fiscal year.

While this approach could work wonders if lady luck is on your side and you end up catching a market bottom; it could work to your severe detriment if you invest at or near a market peak. In other words, the 'throw in the kitchen sink at the last moment' approach to ELSS investing significantly increases your investment risk.

A much smarter, and more convenient approach would be to start an SIP (Systematic Investment Plan) in an ELSS at the start of the fiscal, after computing your projected deficit for the year. For instance - start a monthly SIP of Rs. 6,000 if you've already got Rs. 80,000 out of the Rs. 150,000 covered through other instruments. In doing so, you'll be benefiting from a wonderful mechanism called "Rupee Cost Averaging" which greatly mitigates the risks associated with the vagaries of the stock markets. In the long run, your returns will be a whole lot smoother, and you'll face a lot less heartache if and when markets head south.