Are ELSS more than just tax-saving funds? If so, who are they suitable for?
ELSS or Equity Linked Saving Schemes have long been viewed primarily as tax-saving investments due to their tax benefit under Section 80C. However, ELSS have the potential to be much more than just a tax-saving instrument for investors.
Unlike traditional tax-saving options like PPF, NSC, FD, insurance plans etc. which offer fixed returns, ELSS invest in equities. This allows investors to benefit from the higher growth potential of stocks over the long run. ELSS have delivered inflation-beating returns of 12-15% over the last 5-10 years, outperforming fixed income instruments. The equity orientation allows for wealth creation.
The 3-year lock-in in ELSS is the lowest compared to 5-year lock-in for tax-saving FD and 15 years for PPF. ELSS lock-in allows investors to build equity exposure over a 3-year period before having flexibility to switch funds or redeem as needed. The short lock-in combined with equity growth makes ELSS attractive. When you invest in ELSS through an SIP (Systematic Investment Plan), the lock-in period applies to each individual investment, not the total invested amount.
Open-ended structure of ELSS allows redemption anytime after the lock-in ends. This gives ELSS an edge over traditional options like PPF, ULIP etc. where liquidity is low after lock-in. Easy liquidity allows investors to book profits and redeploy as per asset allocation needs.
As SEBI regulated mutual funds, ELSS portfolios are fully disclosed and transparent. Investors can track the fund’s equity portfolio and performance on a regular basis. Fund managers are also accessible through webinars, e-mail, calls etc. This level of transparency is superior to traditional options.
Low entry barriers
ELSS allow lump sum investment or SIP starting with just Rs 500 per month. This makes it easy for investors across income levels to start investing in ELSS. Low ticket size is especially beneficial for new investors and those belonging to lower income brackets.
ELSS mutual funds are actively managed by experienced fund managers who allocate capital across sectors and stocks. This provides an advantage compared to individual stock picking especially for non-savvy investors. Quality active management can potentially deliver higher risk-adjusted returns.
SIP investment in ELSS allows investors to diversify equity exposure across sectors, market caps, stocks etc. through a single fund. Diversification reduces portfolio volatility compared to owning just a few stocks or investing directly in equity. Minimum 65% equities rule also ensures diversification.
Who is ELSS suitable for?
- Young earners: The long growth horizon and lower risk appetite make ELSS ideal for wealth creation over the long run. Systematic investment plans (SIPs) work very well for young investors.
- Moderate risk-takers: The equity exposure gives higher returns for those willing to take moderate risks compared to fixed income returns.
- First-time equity investors: A simple, low-cost way to take exposure to equities with an experienced fund manager managing the portfolio.
- Goal-based investing: Linking ELSS to an education, retirement, or house purchase goal allows meeting the target through equity growth.
- Wealth creation: The compounding effect over a 5–7-year horizon helps create wealth for future needs.
- Passive investors: Those not keen on actively managing their investments find ELSS a convenient option.
- Portfolio diversifiers: Adding ELSS provides much-needed equity diversification for investors heavily invested in real estate, bank FDs, or gold.
To conclude, ELSS is clearly more than just a tax-saving instrument given its inherent features of growth potential, transparency, liquidity and diversification. It can be a multi-purpose investment vehicle for several investor profiles as per their needs and risk appetite. However, conservative investors with near-term goals may be better off considering safer fixed income tax-saving options. As with any investment, one’s unique situation and financial priorities should determine the suitability of ELSS investments.