Overlook recent outflows and invest in ELSS if you are in old tax regime

They remain attractive for investors having higher risk appetite and longer horizon

While stock markets hovered near all-time highs and inflows into equity-oriented funds remained strong at Rs 40,608.19 crore in June 2024, Equity Linked Savings Schemes (ELSS) or tax-saving schemes witnessed an outflow of Rs 445 crore. These funds have seen outflows totalling Rs 839.2 crore in the last three months.

According to monthly data released by the Association of Mutual Funds in India (Amfi), 42 ELSS have Rs 2.39 trillion in assets under management.

ELSS are equity mutual funds that invest in shares of companies across market caps. “ELSS primarily invest in equities, offering the potential for higher returns over the long term compared to traditional tax-saving instruments like Public Provident Fund (PPF) and Fixed Deposits (FDs),” says S Sridharan, founder and chief executive officer (CEO), Wallet Wealth.

 

Why the lukewarm response?

Being equity-linked, ELSS promises inflation-beating returns in the long run. Over three and five years ended July 26, 2024, ELSS on average have given returns of 20 per cent and 21.2 per cent, respectively, comparable to flexi-cap funds (19.8 and 20.9 per cent). Hence, performance does not account for the recent outflows.

Market experts say the new tax regime is the primary reason for investor apathy. “The upfront tax savings are not so relevant as the new income tax regime doesn’t offer deductions. The lack of tax appeal may be the primary reason for investor apathy,” says Fatema Pacha, senior equity fund manager, Mahindra Manulife Mutual Fund.

“Many investors have shifted to the new tax regime under which no deductions are available under Section 80C. Hence there is no compulsion to invest,” echoes Maheshwari.

Benefits and downsides

Contributions up to Rs 1.5 lakh in an ELSS in a financial year qualify for a deduction under Section 80C of the Income-Tax Act under the old tax regime. ELSS has the shortest lock-in among all tax-saving instruments. “ELSS has the lowest lock-in period of three years,” says Parul Maheshwari, certified financial planner.

But these schemes also expose investors to the vagaries of the stock markets. “ELSS funds are equity-oriented and hence are exposed to market risks like volatility and downturns,” says Sridharan.

The Budget proposed that long-term capital gains on selling equity funds, including ELSS, should be taxed at 12.5 per cent, compared to 10 per cent earlier. (The impact of this tax rate hike will, to some extent, be softened by the hike in exemption on long-term capital gains from Rs 1 lakh to Rs 1.25 lakh in a financial year.)

Who should opt?

ELSS remains attractive for those looking to achieve the twin objectives of tax saving and wealth creation. “Those in the old tax regime looking to save tax under Section 80C and comfortable with equity as an asset class can invest in ELSS,” says Maheshwari.

Investors with a long-term horizon and high-risk appetite seeking capital appreciation can consider investing in ELSS. “Equity investments provide better inflation-adjusted returns,” says Sridharan.

Stagger your investments

Always use a systematic investment plan (SIP) or a systematic transfer plan (STP) to invest in ELSS. “Use the SIP route to invest in equity mutual funds over the entire year as it enables you to participate in the markets and benefit from them,” says Pacha.

Those who prefer index investing may opt for passive ELSS. Two of them track the Nifty 50 Total Return Index (TRI) while one tracks the Nifty Large-Midcap 250 TRI.