ELSS (Equity Linked Savings Scheme) funds – The ignored long term wealth creators

 

ELSS (Equity Linked Savings Scheme) funds are tax-saving mutual funds. These funds provide tax benefits under section 80C of the income tax act. 

We have already discussed the Basics of Mutual funds in the article Mutual funds-What all you need to know (Do it yourself) and the Best mutual funds for beginnersAnother category of mutual funds with multiple benefits is ELSS funds. The benefits, other than the tax benefit under section 80C, of these funds have largely been ignored by the investors. We shall be discussing the less appreciated facts of these long-term wealth creators.





Benefits under section 80C of the income tax act

One of the basic reasons to invest in ELSS funds is the benefit under section 80C of the income tax act. Many first-time investors invest in ELSS funds for tax benefits, and as it has the lowest lock-in period among all other tax saving instruments like Fixed deposit, Public provident funds, etc.

Importance of Lock-in period and continuing the investment after lock-in period

I’ll start with an incidence where a broking firm decided to find out the investor who has earned the highest return over the years. After detailed analysis, they found that the investor who had earned the second-highest return was the one who was not even aware of the investment, and the one who has made the highest return was the one who had expired many years back.

It highlights the importance of doing “nothing”. What you need to do is “buy right and sit tight”. However, the most difficult thing is to do nothing. We tend to be impacted by short-term movements and take decisions that affect long-term performance.

This is one fact why I like ELSS funds as an investment other than its benefits under section 80C of the income tax act. These funds come with a lock-in period of three years. Although, a period of three years is not sufficient to reap the benefits of long-term investing, yet it is better in the scenario where many investors tend to liquidate their investments in a short time frame of 1-2 years.

During this lock-in period, an investor can learn by observing the impact of various external factors on the investment. In most cases the ELSS funds shall beat the return of other tax saving instruments at the end of the lock-in period, however, it is not at the end of lock-in one shall reap the full benefit of investment.

In the words of one of the most successful investors Mr. Warren Buffett

Someone is sitting in the shade today because someone planted a tree a long time ago

It takes time for every tree to attain the size and provide fruit and shade. If we keep on planting and cutting the tree after every two-three years we shall never be able to get the benefits.

The same holds for mutual fund investment as well. A mutual fund investment should be made with a minimum time horizon of seven years with a maximum time horizon of infinity to experience the magic of compounding. I have continued to invest in ELSS funds and haven’t redeemed the investments over the years due to the following advantages these funds offer over other mutual funds.

Flexibility to fund manager

These funds allow flexibility to fund managers to take a long-term view on stocks due to a mandatory lock-in period of three years. The open-ended mutual fund schemes have to face redemption pressure as investors tend to redeem their investment in case of adverse short-term movements in the overall market or fund’s performance. Hence it is difficult for a fund manager to make substantial long-term investment decisions.

The redemption pressure is relatively low in the case of ELSS funds. The fund manager can take long-term decisions without worrying about short-term underperformance.

Focus on Scheme

The mutual fund houses keep on launching new schemes under various categories and with the new scheme the focus on old schemes keeps decreasing. In the case of ELSS funds, most fund houses are offering one scheme and hence these funds tend to perform better due to continuous focus on the scheme.

Rotation of Investment

The investment in a scheme can be rotated after three years. Let us understand the same with an example. It helps in getting tax benefits under section 80C in case you are unable to do fresh investment in any financial year along with the reduction in Long term capital gains tax.

Let us assume that you had invested an amount of Rs. 1.50 lac in a tax saver fund in 2018 and the value of same in 2021 is Rs. 2.25 lac. You can redeem and reinvest Rs. 1.50 lacs in 2021 to get the tax benefit under section 80C.

Further, the long-term capital gain tax is charged if the long-term capital gain exceeds Rs. 1.00 lac in any given year. With the rotation of Rs. 1.50 lac, Rs. 50000 of capital gains shall get reinvested and hence reducing the future tax liability.

Seems difficult to understand. Don’t worry. Once you start investing and learning you will understand it in due course.

Due to the above factors, ELSS funds have been one of the best funds investing in companies of all sizes and benefiting from long-term investment horizon. These funds have been proved to be great wealth creators.

Best ELSS Mutual Funds

Following are some of the best tax saver schemes. As we have discussed in the article Mutual funds- Whatall you need to know (Do it yourself),  invest through direct plan only to gain maximum from the investment.

Mirae Asset tax saver fund-Direct - Growth

MiraeAsset Tax Saver fund –Direct-Growth is one of the best funds in the category. The scheme is managed by Mr. Neelesh Surana, CIO, Mirae asset Investments. The scheme has delivered approximately 20% annualized return since inception. The expense ratio of the scheme is 0.29% which is one of the lowest.

ICICI Prudential long term equity fund- Direct-Growth

ICICI Prudential long term equity fund is one of the oldest tax saver funds and has delivered an annualized return of approximately 15% since inception. The scheme is managed by Mr. Harish Bihani. The expense ratio of the scheme is 1.30%. The scheme is suitable for conservative investors.

Axis long term equity fund-Direct-Growth

If you are an aggressive investor, Axis long term equity fund is the suitable scheme for you. The scheme is managed by Mr. Jinesh Gopani and has delivered an annualized return of approximately 19% since inception. The expense ratio is 0.72%.

DSP tax saver fund-Direct-Growth

DSP tax saver fund is managed by Mr. Charanjit Singh and Mr. Rohit Singhania. The scheme has delivered an annualized return of approximately 17% since inception and has an expense ratio of 0.80%. The fund is suitable for conservative investors.

Parag Parikh tax saver fund-Direct-Growth

Parag Parikh Tax Saver Fund is one of the recent tax saver schemes with the existence of fewer than two years. The fund is managed by Mr. Rajeev Thakkar, Mr. Raunak Onkar, and Mr. Raj Mehta. The fund has an expense ratio of 1.19%. I have added this scheme to the list only due to the long-term investment philosophy of Parag Parikh fund house, one of the most respected fund houses. The scheme is expected to do well over the long term.

(I have deliberately not discussed the return of the scheme as the short-term returns are not representatives of long-term performance. However, for information purpose only, the is 25% since inception mainly due to run up in markets after COVID-19)

 

The investors may make a detailed study of the schemes and invest based on the same or with the help of a financial advisor.

Bottom-line

ELSS funds are one of the best funds for long-term wealth creation and may be considered to achieve long-term goals.

 Mr. Warren Buffett has famously said

 I made my first investment at age eleven. I was wasting my life up until then.

 So if you have yet not started investing start with ELSS funds and then add funds as per your comfort to create wealth.

 

Have a successful investing.

 

 

Sources:

https://www.moneycontrol.com/

 

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