Investors looking to participate in the financial year-end rush to save taxes under Section 80(C) are in a quandary. The recent move to demonetise Rs 1,000 and Rs 500 currency notes has resulted in a precipitous drop in five-year deposit rates. Rates of return on the popular NSC and PPF, at 8 per cent, are no longer lucrative either. Traditional (non-linked) life insurance policies are frustratingly opaque with respect to their benefits, yield extremely poor returns over the long run, and severely lack interim liquidity.
In such a scenario, ELSS (equity- linked savings schemes) represent a formidable option. In a nutshell, an ELSS is an equity-based, diversified mutual fund scheme with a hard lock-in period of three years.
Run by professional fund managers, mutual funds spare investors the hassle of having to navigate the complex maze of the securities markets themselves. As a category, the ELSS mutual funds have delivered an impressive annualised return of 16.74 per cent over the past five years.
“ELSS offers you the opportunity to grow your money by investing into the equity markets,” says George Heber Joseph, fund manager with ICICI Prudential AMC.
Come January 2017, investors who are falling short of the Rs 1.5 lakh limit on their Section 80(C) deductions should seriously consider investing into an ELSS, before reactively purchasing life insurance for the same.
How They ScoreELSS funds score over their traditional counterparts in terms of the superior tax efficiency of their returns, their comparatively shorter lock-in period, and their better odds of helping you create long-term wealth. Any profits that are booked when you redeem your ELSS fund units will be counted as long-term capital gains from equity funds, and will therefore not be taxed.
Sundeep Sikka, Executive Director and CEO, Reliance Nippon Life AMC echoes this view when he notes that almost all other alternatives offer fixed interest income level returns that barely beat inflation over the long term. Sikka describes ELSS as “a unique product category offering an optimal combination of wealth creation along with tax saving”.
A word of caution is warranted here: the stipulated three-year lock-in is an insufficient time horizon for equity investing. Although the hard lock-in finishes within three years, you will be better off investing with a view of at least 5-7 years. Lock-in period notwithstanding, ELSS investors remain free to hold their units for as long as they would like to, as the investment doesn’t have any stipulated ‘maturity date’.
The Lock-in Works in Your FavourThe obligatory three-year lock-in works in your favour in two ways. First, it forces investors to shrug and look the other way if markets start correcting soon after they invest. In doing so, it automatically helps them overcome a firmly ingrained behavioural trap known as the “loss-aversion bias”, which could have otherwise prompted them to liquidate their investment in panic. Left with no option other than to ride out the volatile patches, their forced passivity normally ends up serving them well.
The second benefit of the lock-in accrues to the fund manager; and to investors as an indirect outcome. Spared the need to provision for untimely and often irrational customer initiated redemptions, ELSS fund managers revel in the flexibility to take longer term investment decisions that have the potential to unlock deeper value.
Referencing their in-house ELSS Reliance Tax Saver Fund that has grown 4.8 times since its NFO in 2005, Sikka says,“The stable investor profile given the three-year mandatory lock-in assists in identifying high conviction ideas that are likely to play out over the medium term, thus resulting in significant long-term wealth creation.”
No, They Don’t Suit Everyone
Be cautious of advisors touting ELSS funds as the promised land when it comes to tax saving and wealth creation. Every individual is unique, and every investment doesn’t suit every person. We all carry with us our own distinctive risk profiles, past experiences, and future expectations from our investments; therefore, a thorough risk profiling or suitability assessment test is essential before making the final decision to invest into an ELSS. Despite their definite potential for long-term wealth creation, it remains true that equity investing can, on short notice, turn into a nightmarish roller-coaster ride if markets turn bearish.
Case in point: the trusty Birla Sun Life Tax Relief ’96 Fund (an ELSS) that has an impressive five-year return of 19.92 per cent annualised, tanked an astronomical 65 per cent in the hellish 12 months between December 2007 and December 2008!
If you are extremely risk averse and the prospect of having to stomach short- to medium-term losses makes you more than just a little nervous, ELSS funds may not be for you. Opt for them only if you have complete clarity on what you are getting into, and if you are willing to extend your time horizon by at least two years on short notice; just in case your lock-in ends amidst the throes of a bear market.
SIPs Work BestIt would be wise to put your tax savings on auto-pilot by starting a SIP (systematic investment plan) in an ELSS at the start of the financial year, instead of committing a lump sum of money at the penultimate moment. Apart from the obvious benefit of making it easier on your pocket, doing this will help smooth your long-term returns by averaging the overall purchase price of your units through the inevitable ups and downs of the equity markets. Do bear in mind that each SIP tranche will be counted as a distinct purchase, and will subsequently be locked-in for three years.
For an even better outcome, you could map your SIP investment in an ELSS to an important long-term financial objective; the achievement of an important goal or two could be a fortuitous side effect, along with the obvious tax-saving benefit.
