In a few weeks from now, people across India will start getting restless about whether they have done their bit to save taxes this year or not.
Tax-saving equity linked saving schemes (ELSS) funds often figure in lists of good tax saving options for Indians. And why not? The returns delivered in the past have been pretty reasonable as the instrument invests in equity. So, good returns are an added benefit over and above the tax relief via Section 80C.
But, to be very blunt, there is nothing unique about an ELSS. It is just an equity fund with a lock-in period of three years. And being a vehicle investing in equity, it comes with all the risks associated with equities.
So, many times, people wonder whether they should invest a lump-sum in ELSS or go for a staggered approach of regular SIPs in ELSS funds.
But before addressing this question, let me highlight something important.
Just because the lock-in in ELSS is three years, it doesn’t mean that it is good to remain invested in it only for three years. ELSS is an equity product and hence is suitable only for long-term investments. Ideally, you should be willing to remain invested in it for more than five years (or even longer). Equity markets can be volatile in the short term and if you want to earn good returns, you may have to wait for long.
Investing in tax-saving funds
If you want to invest a lump-sum, it means you are trying to time the market, consciously or otherwise. And that is very difficult even for market experts. You cannot be sure whether the market is at a low or not. There is always the danger of catching the market at a wrong time. To be fair, let’s also acknowledge that it’s possible you may end up timing the market perfectly. Then, obviously, you will make tons of money.
But point is: do you really know when the right time to invest in the market is? If you do, then you are a good investor and will make money. But if you aren’t, then by putting money in one go, you are taking a chance, which may or may not work in your favour.
This is the reason why good investment advisors generally ask people to stagger their investments in equity. This is to avoid being completely wrong due to poor timing. And since ELSS is an equity product, it’s also suitable for periodic investments in most cases.
You need to understand that there is nothing wrong about investing lump-sums in ELSS. It is just that most of us cannot predict the market accurately. Hence, we would be better off staggering our investments to average the purchase cost. It is not a perfect strategy but the best bet for common investors.
And this can be the ideal way for new investors to participate in equity markets (and build a mutual fund portfolio) without having to worry about timing the market and trying to arrange for a large amount in one go.
There is one more aspect that many people misunderstand about ELSS lock-ins. If you invest in lump-sum, the entire amount is locked-in for three years. But, if you invest via SIP, then each ELSS SIP instalment is a fresh investment with a new starting date. Thus, every SIP instalment is locked-in for a period of three years.
That said, ELSS is no doubt a good tax saving option for investors looking to invest in equity. But trying to time investments via lump-sums is not easy due to the very nature of markets. So, unless you are really sure about your market timing abilities, you are better off staggering your ELSS investments over the full financial year. It can be done via SIP or you can do it manually once a month or once every two months too.
Avoid making a lump-sum investment in ELSS fund during the end of the financial year to save taxes, with the hope of getting it right. It may not work in your favour every time.(The writer is the founder of StableInvestor.com)