Don't let poor three-year returns deter you from investing in ELSS

If your equity exposure is low, invest in them for tax saving purpose

Investing for tax saving is likely to be one of your top priorities in the coming days. These investments should not be deferred entirely till the fourth quarter as you could come under finan­cial pressure then. One of the options you should consider is tax-saver mutual funds (also called equity-linked saving schemes or ELSS). At 4.3 per cent, the category average return from these funds has been disappointing over the past three years. This figure has recovered to 8.9 per cent for the past year. Nonetheless, if you are unsure about whether these funds are a good bet, read on.  

Why did returns decline? Tax-saver funds invest in equities across market caps. “Over the past three years, there was significant consolidation in the mid- and small-cap segments. We have also witnessed a slowdown in the Indian economy, liquidity crisis in the NBFC sector, and re-categorisation of mutual funds by the Securities and Exchange Board of India (Sebi), which led to many funds removing small- and mid-caps from their portfolios. All these factors contributed to the low compound annual returns of these funds,” says Harsh Jain, co-founder and chief operating officer, Groww.

Mid- and small-cap stocks were trading at elevated levels in November 2017. They tanked after January 2018, and have just about recovered now. Since a considerable portion of the portfolio of these funds is in mid- and small-caps, their three-year returns look poor.    

The ELSS advantage: Tax-saver funds should nonetheless remain your top pick. “Investing in ELSS gives you the dual benefit of tax deduction and wealth creation over time. These MFs have the potential to offer the highest returns among all Section 80C investments,” says Archit Gupta, founder and chief executive officer, ClearTax.com. Investors whose portfolio exposure to equities is low should definitely invest in them.  

The alternatives: Bank fixed deposits (FDs), National Savings Certificate (NSC) and Public Provident Fund (PPF) are alternatives you should consider. A low interest-rate environment has made the five-year tax-saving bank FD unattractive. The State Bank of India is offering an interest rate of 5.4 per cent on its five-year tax-saving term deposit. While PPF (7.1 per cent) and NSC (6.8 per cent) offer better returns, they come with a 15-year tenure (partial withdrawal allowed from the seventh year) and five-year tenure (lock-in until maturity). In Sukanya Samriddhi Account (7.6 per cent rate of return), the lock-in is 21 years (partial withdrawal allowed once the child reaches 18). ELSS has a lock-in of three years only.  (see table).

Tax-saver funds are also tax-efficient. “You pay tax at 10 per cent if your capital gain is over Rs 1 lakh and none if it is under this amount,” says Adhil Shetty, chief executive officer, Bankbazaar.

Not for the risk-averse: “Risks will be inherently higher in ELSS than in PPF, NSC or FDs,” says Jain. To counter it, hold your investment beyond the three-year lock-in and ride out market cycles. 

“ELSS can help pad up your portfolio return if you are not in a hurry to pull out your money,” says Shetty.