These funds can fetch double-digit returns over the long term which debt tax-saving products can't.
The Rs 158,199.6-crore equity linked savings scheme (ELSS) category, popularly called tax-saver funds, disappointed investors in 2022 by giving a meagre return of 1.9 per cent.
As we enter the last quarter of the year, and salaried employees scramble to submit evidence of their tax-saving investments, a large number will ask whether investing in ELSS is a good idea after their recent abysmal performance.
Strong long-term track record
The ELSS category is purely equity oriented. And equities have the potential to offer higher returns than debt products over the long term.
ELSS funds have given a category average return of 13.7 per cent over the past 10 years.
Debt-oriented tax-saving products can't give such high returns.
"As they are professionally managed funds, they have the ability to create wealth, or at least generate inflation-beating returns over the long term," says Umesh Kumar Mehta, chief investment officer, Samco Mutual Fund.
Investors have to pay capital gains tax when they redeem these funds: 10 per cent on long-term capital gains above Rs 1 lakh, and 15 per cent in case of short-term capital gains.
Even then their post-tax returns are likely to surpass that of debt-oriented tax-saving products over the long term.
Another advantage is their short lock-in.
"ELSS has the shortest lock-in period among all Section 80C instruments," says Mehta.
The lock-in of three years works in favour of investors who tend to exit equity funds at the first sign of a downturn.
Investors can enjoy tax deduction of up to Rs 1.5 lakh under Section 80C by investing in ELSS.
Be prepared for volatility
Investors must, however, be prepared for periods of volatility.
In the past 10 calendar years, there have been four -- 2015, 2016, 2019 and 2022--when their category average return was in the single digit. It was negative in 2018.
"Since these funds invest in equities, returns are not assured," says certified financial planner Parul Maheshwari.
Investors should stay invested in ELSS even after the three-year lock-in ends.
"The holding period should be long enough for the investments made by the fund manager to complete one bull-bear-bull cycle. Generally, well-diversified equity funds have managed to give inflation-beating performance over a five-seven-year period," says Mehta.
Parijat Garg, fund manager and executive vice president, IIFL Asset Management, also echoes this view.
"If the fund you've invested in is doing well, there is no reason to redeem just because the lock-in period has expired," he says.
Select a fund that has invested in quality businesses.
"In the long run, a fund's performance can't be better than that of the underlying businesses it has invested in," says Mehta.
He adds that the portfolio should be diversified and the fund should have a consistent long-term track record vis-a-vis its benchmark and peers.
Don't diversify across too many ELSS. Keep investing in the same carefully-chosen scheme via the systematic investment plan (SIP) route.
Go for new ideas?
While IIFL MF has launched a passive ELSS that tracks the Nifty 50, Samco MF has launched one that will be mid-cap and small-cap oriented (most ELSS are flexi-cap oriented).
Financial planners say a passive ELSS is a good idea for some investors.
"If you are a conservative investor who wants to avoid fund manager risk, go for the passive fund. Aggressive investors should stick to actively-managed ELSS," says Maheshwari.
While making an ELSS mid-cap and small-cap oriented would increase its volatility, Samco MF believes the concept can work due to the three-year lock-in.
Viral Bhatt, founder, Money Mantra, believes a flexi-cap oriented ELSS fund would offer better risk-adjusted returns.
"The large-cap component offers better downside protection. A mid-cap and small-cap oriented fund will be hit more during a downturn."
Let Samco MF's fund develop a track record before you invest in it.
Opt for it only if you have adequate exposure to large-cap funds and need more mid-cap and small-cap exposure to your portfolio.