ELSS gives much higher returns due to the power of compounding despite the market volatility it entails.
Are you a risk-averse investor who likes secular growth with no volatility in the investments? Also, do you invest basically to save tax? And do you use the 5-year bank fixed deposits route or the Public Provident Fund route or the insurance-based investment products of unit-linked insurance policies or endowment?
Too many questions at one go? Well, these questions will indicate the kind of investor you are.
However, mutual fund investment schemes also offer an investment avenue to save tax and at the same time offer a lower lock-in period of three years. This scheme is called Equity Linked Savings Scheme (ELSS) and is offered by all the asset management companies. What it does not offer is secular growth, but compounded growth with volatility. And it is this volatility, which does not find preference with most risk-averse investors.
Tax benefits in ELSS
When you invest in instruments that are eligible for taxable income deduction under Section 80C of the Income Tax Act, the maximum allowable investment amount is `1,50,000. Also, the amount invested is locked-in. What it means is that on the basis the regulation, one cannot redeem the investments for a certain period of time. In case of bank fixed deposits, it is five years. With PPF, it is 15 years (for complete withdrawal) and in case of ELSS, it is three years.
If, as an investor you can invest in PPF for a duration of 15 years and you are willing to wait till the 16th year for withdrawal, why cannot you invest in ELSS schemes? Though ELSS has a higher volatility, it offers compounded growth rate.
Let us understand with an illustration. Say, you started investing only to save tax under Section 80C as per the limits for investment at the point of time—`70,000 from April 1999 to April 2009, `1 lakh from April 2010 to April 2014 and Rs 1,50,000 from April 2015 to April 2017. A total investment of `17.20 lakh. The BSE Sensex during this period moved from levels of 3686 to little less than 32,000 levels in March 2018, over 8.9 times .
The PPF corpus grew to Rs 33.80 lakh, close to two times the total corpus invested on an absolute return basis. Alternatively, if you had invested in one of the leading ELSS schemes of the mutual funds, the amount grew over 7.5 times in absolute terms to have a corpus of Rs 130 lakh.
Equity—the long-term winner
What corpus would you have preferred? Rs 33.80 lakh or Rs 130 lakh? The answer is obvious!
When you look at the returns, point to point, the decision looks easy—hindsight bias. In this 15-year period, the Sensex ended the year negatively on five different occasions. That means one-third of the times, the Sensex was in red. And to add to it, for the first five investing years, the returns generated by PPF was more than the returns generated by the ELSS schemes. It was only from the 6th year onwards, did the ELSS schemes generate a corpus higher than PPF and then over a 15-year period, the absolute returns generated were more than three times the returns generated by the PPF.
Again, if you change the period from the year 1999 to 2003 or 2007, the returns generated by the ELSS schemes are higher than those generated by fixed income schemes under which the Section 80C investments are effected, as of date.
If you can withstand the volatility or if you can understand volatility and make it your friend, then the price movements in NAV of the ELSS schemes should not be a matter of concern. Educating oneself is the mantra in wealth creation. The power of compounding gets more accentuated, over a longer time frame. Frame the investment period when you invest so that you do not miss out on larger corpus only because you had not educated or informed yourself in the investment journey.
Brijesh Damodaran is founder and managing partner, BellWether Advisors LLP