(This article was first published on NDTV Profit.)
Yes, equity-linked savings schemes or ELSS funds are risky. Since these tax-saving mutual funds invest in the stock markets, they come with equity-related risks. If the markets go through a bear phase, even the best ELSS funds can see an erosion in the value of their portfolio.
During a bull run, an ordinary ELSS fund will also be able to generate returns, but a bear phase will separate the best from the rest. What a good fund will be able to do is earn well when the going is good and contain the fall when things go bad. But even then, ELSS funds do come with a fair share of risk. Their performance is dependent on the companies they invest in.
ELSS funds diversify their portfolio by investing in different companies to mitigate the risks associated with any single stock. But things can still go wrong. A particular holding may not do as well as expected or a sector that the fund is overweight on may see a prolonged depression. A manager is at the helm of a fund and the chance of a human error also has to be factored in.
So yes, ELSS funds are a risky investment. But even then, they are worth the risks. ELSS funds are a recommended investment by experts because they have certain advantages to them that other tax-saving investments don’t come with. These are benefits that only ELSS funds can boast of. And it is because of these reasons that taxpayers should invest in them.
Equity performs best over long-term
The first reason to invest in an ELSS fund is the high returns that equity can earn. Over the long term, which means periods of 5-10 years, equity has majorly outperformed fixed income investments. Most fixed income tax-saving options like PPF (public provident fund) and FD (fixed deposit) offer returns in the range of 8 per cent. This kind of return won’t help you beat inflation. ELSS funds, on the other hand, have generated returns in the range of 12-15 per cent over most 10-year periods. This means that you not only earn higher returns, but your invested capital is also protected from erosion.
Bad times become great opportunities
A downturn in the economy would be a bad signal for fixed income investments. They invest in bonds that are hugely dependent on the economy. Of course, even companies depend on the economy, but a temporary downturn – when the stocks of good companies plummet – can turn out to be a great buying opportunity for investors through the ELSS funds they have. When ELSS funds can invest in good stocks at lower prices, they will generate good returns once the downturn ends and the economy starts doing well. This is why investing in ELSS funds even through a bad phase is recommended.
Highest flexibility among tax-saving investments
Fixed income tax-saving investments come with long lock-in periods. ELSS funds have a lock-in of only 3 years. Apart from that, ELSS funds have further flexibility in terms of stopping an investment in a fund that isn’t doing well. Even though the funds come with a lock-in period, you can stop investing in it any time. If the ELSS fund you’re investing in doesn’t do well, you can move to another fund. You can also diversify your ELSS portfolio by holding more than one fund. This kind of flexibility isn’t available with traditional tax-saving investments.
Returns are tax-free
All earnings made from an ELSS fund investment held for over one year are completely tax-free for the investor. Most fixed income investments are not tax-free, and the ones that are have long lock-in periods. In ELSS funds, by the time your lock-in period ends, the returns earned on the investment will be tax-free for you. This is a big benefit of ELSS funds that allows it to trump traditional investments.
This is how ELSS funds are one of the finest tax-saving investments. You can invest up to ₹ 1.5 lakh in ELSS funds to save taxes under Section 80C. The risk that they come with is more than compensated for by the benefits they give.