The benefits of ELSS investment for the salaried class

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, ELSS mutual funds  have delivered an impressive annualized return of more than 12% per annum over the past five years and close to 15% per annum over a 10 year timeframe. Tax Saving Mutual Funds offer you the opportunity to grow your money by investing into the equity markets. Seriously consider investing into an ELSS, before reactively purchasing life insurance for the same.

How they score

ELSS 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.

Almost all other alternatives other than tax saving mutual funds offer fixed interest income level returns that barely beat inflation over the long term. This makes ELSS Funds a unique product category offering an optimal combination of Wealth Creation along with Tax Saving.

A word of caution is warranted here: the mandated 3-year lock in for ELSS funds is an insufficient time horizon for equity investing. Although the hard lock-in finishes within 3 years, you’ll be a lot better off investing in an ELSS for a long-term financial goal like your retirement. Lock-in period notwithstanding, ELSS investors remain free to hold their units for as long as they’d like to, as tax saving mutual funds don’t have any stipulated ‘maturity date’.

The lock-in works in your favour

The obligatory 3-year lock-in for ELSS funds actually works in your favour in two ways. First, it forces you to shrug and look the other way if markets start correcting soon after you invest. In doing so, it automatically helps you overcome the “loss-aversion bias”, which could have otherwise prompted you to liquidate your tax saving mutual fund investment in panic. Left with no option other than to ride out the volatile patches, their forced passivity normally ends up serving you well!

The second benefit of the lock-in accrues to the Fund Manager of the ELSS Funds; and to investors as an indirect outcome. Spared the need to provision for untimely and often irrational customer-initiated redemptions, Tax Saving Mutual Fund Managers enjoy higher flexibility to take longer term investment decisions that have the potential to unlock deeper value.

Basically, the stable investor profile given the 3-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 for investors of ELSS Funds.

No, they don’t suit everyone

Despite all their advantages, tax saving mutual funds are not suitable for all investors, especially if they do not understand the risks involved. Every individual is unique, and every investment doesn’t suit every person. We all carry with us our own distinctive risk profiles, past investing experiences, and future expectations from our investments; therefore, getting a thorough understanding of the risks involved is critical before investing into ELSS Funds. Despite their definite potential for long-term wealth creation, any form of equity investing can (on short notice) turn into a nightmarish roller-coaster ride if markets turn bearish.

If you’re extremely risk averse and firmly believe that any sort of short-term losses will lead to irrational behaviours, tax saving mutual funds funds may not be for you. Go for ELSS Funds only if you have complete clarity on what you’re getting into, and if you’re willing to extend your time horizon by at least two years on short notice; just in case the lock-in period for your tax saving mutual fund ends in the middle of a bear market like the one we saw during the early days of COVID-19.

SIP’s work best for ELSS Funds

It’s wise to put your tax saving mutual fund investment on auto-pilot by starting a SIP (Systematic Investment Plan)  in an ELSS at the start of the Financial Year, instead of investing a lump sum into an ELSS Fund at the end of the year in one shot. Apart from the obvious benefit of making it easier on your pocket, doing this will help smooth the long-term returns from your tax saving mutual fund by averaging the overall purchase price of your units over time. Do keep 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 align your SIP investment in your ELSS Funds to an important future goal; the achievement of an important milestone or two could be a desirable side effect of investing into a tax saving mutual fund, along with the obvious tax-saving benefit!