Tax saving mutual fund schemes or equity linked saving scheme (ELSS) are one of the most preferred options to save tax for most individuals. It comes with a three-year lock-in period. Although there is no restriction on the amount one can invest in it, investments up to Rs 1.5 lakh in a financial year is exempt under section 80C of the Income Tax Act. The recent budget kept the section 80C limit of Rs 1.5 lakh intact.
Although no rule bans investments in excess of Rs 1.5 lakh per year, one should not invest money in excess of what is required in ELSS. Primary reason behind this is the three-year in lock in period. Financial planners advise investing in equity mutual funds with long-time frame – typically in excess of five years and in that case three-year lock-in is not a hindrance. It makes sense to invest in a product for long-term by choice and not out of force.
ELSS portfolios comprise stocks of companies of all sizes – large, mid and small. This is akin to a multi-cap portfolio. Over 10 years, multi cap mutual funds have given 17.66 percent returns whereas ELSS has given 17.18 percent returns, according to Value Research as on February 1, 2019. Over the past five-year time period, multi-cap funds gave 16.23 percent returns and ELSS gave 16.31 percent returns. To put it straight, the ELSS schemes with lock in do not offer more than the multi-cap funds with no lock in.
One should also not ignore the changing risk appetite of a person and the costs of investing in mutual funds. The risk appetite of a person may go down over a period of time and for him it may be a prudent idea to stick to large cap stocks.
In that case one would be better off with large cap equity funds. The large cap equity funds offer less returns compared to ELSS, but they are less volatile. For example, large cap funds recorded standard deviation of 14.31 for the 3-year period ending as on January 31, 2019, whereas ELSS funds recorded standard deviation 15.14 over the same period. Standard deviation measures volatility and seen as a measure of risk. Low number connotes low risk.
ELSS funds charge expense ratios in the range of 1.46 percent to 2.88 percent, whereas if one intends to invest through an index fund (for large cap exposure), then the expense ratios are in the range of 20 basis points to 2%. In case of large cap focussed ETF tracking Nifty, the same goes down to 5 basis points.
What’s the need to invest in an ELSS then? Given that the returns aren’t exceedingly more than diversified funds, there’s no pressing need to invest more than what’s required to get you the tax benefits.
Then again, the basket of instruments available for us to invest to get the section 80C tax deduction benefits is dominated by fixed income instruments where, apart from public provident fund, interest income is taxed. All of them come with long lock-ins. ELSS is the only pure equity vehicle and it also comes with a shorter lock-in of three years.
If you must invest in an ELSS fund, provided you still have space to invest in section 80C basket of instruments after your employee provident fund and public provident fund, have a 5-year time horizon at least to improve your chances of earning decent returns over your fixed income instruments. But given the wide variety of risk levels between the bouquet of tax-saving funds on offer, it makes to stick to those that are diversified.
Either ways, avoid investing more than Rs 1.5 lakh in a tax savings fund. If you have more money to invest, it is important to look beyond ELSS.