3-Tax saving By Equity Linked Saving Schemes ELSS - Part III

This is part III of the article Tax saving By Equity Linked Saving Schemes ELSS - Part I. Please read the part I of the article before continuing with this section.


What are the problems that we see here for ELSS?
• Mutual Fund Problems – ELSS is a Mutual Fund and Fund manager is a human being, he is no God who would always select the best stocks
• Commissions: Eat up majority of the profits. Even if the fund manager picks up the best performing stocks, the commission ensures that your profits are hit severely.
• Also note from my previous articles that no fund manager can consistently perform better than the market. Three year long horizon, he is sure to miss out atleast in one year. If unfortunately, that happens to be the 3rd year, your maturity money will be affected. You always have the option to carry on with your investment, but each year you’ll have to pay the charges and commission to the fund manager and there is no guarantee that he will perform better in the coming years.
• Ignorance by the investor: Primary cause, the only thing that can be done is to learn, learn and learn – atleast learn to make calculations of profit and loss
• And remember, we are talking about the BEST PERFORMING ELSS scheme here. Imagine what might happen if you end up with investment in a worst performing ELSS. Forget about tax-savings and capital appreciation, even your principal invested amount will go for a toss.
• Also to note that the overall market has gone up during our investment period. Imagine what may have happened if the markets had gone down. The fund would have performed much worse than the ETF. Though you will receive a ONE TIME tax benefit.

We can only make a calculated bet, when it comes to making predictions about the 3 year long horizon for making investments in tax saving schemes. If you are ready to take the risk, then I would suggest you to go ahead and make an investment in ELSS, at a time when you believe the market has corrected or gone down. Remember, your money will be locked in for 3 years. A good way to invest is to split your investments in 2 parts:
• Part 1: Invest in Nifty/Sensex based ETFs – no tax benefit
• Part 2: Invest in mid-cap based ELSS – with tax benefit

If the overall market goes up, you will gain on both the fronts – no doubt about that. However, if the market goes down, then you will loose on ETFs. There is some chance that mid cap based ELSS will give you some better returns or less loss than the main index based ETF and you also get tax benefit. OR, you may also switch the two, mid cap based ETF and Index based ELSS. It depends upon your perspective. If tax saving is the sole purpose of your investment AND you are willing to take the risk, then go for ELSS, with the EXTRA MONEY that you don’t need. In case your returns are not good at the end of 3 year lock in period, think about extending it further, though it comes at a cost. If tax savings is your sole purpose but you are not willing to take the risk, go for Tax saving bonds with the same 3 year lock in period. If length of investment is not a constraint and tax saving is your sole purpose, then go for NSC (6years) or PPF (15 years). Concentrate on the PURPOSE of your investment, your investment HORIZON and your RISK appetite.

In essence, I would say that people who do advocate for investing in Mutual Funds, should instead invest in Tax saving Mutual funds or ELSS – but with the investment split across different segments of the markets – bluechips, midcaps & smallcaps. If you want to diversify your portfolio, diversify it at a broader level in terms of market segments, instead of diversifying at individual stock levels. Stock investment is considerably more risky, as compared to segment level.

How do PPF figures when compared to the ELSS or ETF?
Basically, it will not be worth comparing 2 products which have completely different maturity horizons. Unfortunately, there is no ELSS scheme data available that can be traced back to 15 years in the past. In PPF, your money is locked in for a 15 year long horizon, but with certain assured rate of return. You have the option of early withdrawal, but it will again take lengthy calculations and predictions about the interest rate changes. Keeping things simple: make calculations for the entire 15 year horizon and make the investment for a purpose if you want to consider PPF.

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You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.