Should you stick or twist? What to do with ELSS funds in new tax regime

With more and more Indians opting for the new tax regime in India, investments into Equity-Linked Savings Schemes (ELSS), which are traditionally popular for tax-saving purposes, are dipping. Under the new tax regime, many taxpayers may find it more beneficial to opt for the simpler, no-exemption tax system, which does not encourage investments in instruments like ELSS that offer tax deductions.

 

ELSS funds have historically provided attractive returns, averaging around 13-14% annually over three to five years, with some fluctuations. However, with the new tax regime reducing the upfront tax benefit of ELSS investments, does continuing with these funds still make sense? Especially for those who have completed the three-year lock-in period.

 

 

Data analysed by Value Research reveals this: 

 

Three-year period: Over any three-year period in the past decade, ELSS funds have delivered an average annual return of 14.24%. This means that, on average, these funds have grown at a rate of 14.24% per year over a 3-year investment horizon. However, the minimum return during any three-year period was -7.2%, meaning there were instances when an investor could have experienced a loss in value over three years, though this was the worst-case scenario.

 

Five-year period: When we look at a longer, five-year horizon, the performance is slightly more stable. The average annualized return over five years was around 13%, which is still a strong performance, though slightly lower than the three-year period. The minimum return over five years was -2.12%, indicating that even in the worst five-year period, the investment did not dip as drastically as it could have in the worst three-year period. This suggests that longer-term investments in ELSS have a greater chance of mitigating short-term volatility.

 

Seven-year period: Over an even longer investment horizon of seven years, the returns remain consistent. The average annualized return continues to hover around 13%, which suggests that ELSS funds can offer stable returns over the long term. The minimum return during any seven-year period was -7.23%, which, while still a loss, is better than the minimum return during shorter periods, showcasing how a longer investment period can help smooth out market fluctuations.

 

How ELSS funds compare to flexi-cap funds?

 

"For all practical purposes—except for the three-year lock-in period and tax benefits—ELSS funds are as good as any other diversified equity funds like flexi-cap funds to build long-term wealth. Like them, ELSS funds have the flexibility to invest across companies of different sizes and sectors, providing you with diversified exposure. So, if we were to compare an average ELSS fund's performance with an average flexi-cap fund, you'd see them both churning out similar returns. Both categories gunned out an annualised return of 13 per cent on a five- and seven-year basis. Hence, sticking to either option is conducive for long-term wealth building," said Siddhant Madhav Joshi of Value Research. 

 

So, should you stick or twist with ELSS investments? Joshi presents the case for investors whose Equity-Linked Savings Scheme (ELSS) investments have crossed the three-year lock-in period, and they need to consider whether to stick with these investments or switch to alternative options.

 

Should You Withdraw? If you need the money or have already achieved your investment goal, withdrawing your funds from the ELSS might be the right choice. The three-year lock-in period is over, so there’s no longer any restriction on accessing your money. In such cases, it may be sensible to redeem your investment and use the funds as needed.

 

Should You Stay Invested? If you do not need the funds immediately, keeping your investment in the ELSS might still be a good option, particularly if you extend your investment horizon. Extending the holding period to five, seven, or even ten years can allow you to take full advantage of market cycles and the power of compounding. Longer holding periods historically yield better returns, according to the data, as market fluctuations tend to balance out over time, resulting in higher overall growth.

 

Evaluating Fund Performance: If you're dissatisfied with your ELSS fund's performance, a thorough, data-driven evaluation is crucial. You should compare your fund’s performance against other ELSS funds or even flexi-cap funds (which are non-tax-saving funds) to gauge its relative performance. Additionally, comparing the fund's returns with a benchmark like the BSE 500, which represents diversified funds, can provide a clearer picture of how it is performing in the broader market context. Looking at the fund’s performance across various market cycles is essential to understand whether the underperformance is a short-term fluctuation or a more long-term issue.

 

What to do if Fund is underperforming: If your ELSS fund has been consistently underperforming for two to three years, it may be time to consider switching to another diversified fund. This helps ensure that your investments are aligned with your financial goals and objectives.

 

Reassessing SIPs (Systematic Investment Plans): For investors making regular investments through SIPs in ELSS funds, the article recommends reassessing this strategy in light of the new tax regime. Since the new tax regime reduces the importance of upfront tax benefits, shifting SIPs to a flexi-cap fund could be a wise move. These funds provide similar diversification and long-term growth potential but may better align with your current financial goals.

 

The Discipline of ELSS: However, if you are someone who tends to make impulsive investment decisions, sticking with your ELSS investments may provide a sense of discipline. The mandatory three-year lock-in period acts as a safeguard against making hasty decisions, forcing you to hold onto your investments and follow your long-term plan.