An Equity Linked Savings Scheme (ELSS) is basically a scheme wherein the amount invested in the units of the fund is invested in the equity shares of the companies. It is the only mutual fund which qualifies for a tax deduction of up to Rs. 1.5 lakh annually under Section 80C of the Income Tax Act.

Key features that differentiate ELSS from an open ended diversified fund are tax benefit and a lock-in period of three years. Therefore ELSS offers investors a window to benefit from the “power” of equities and also claim tax benefits too.

No doubt PPF and NSC offer investors an assured return but equities have the potential to offer a higher return in relation to fixed income avenues.

Are ELSS funds risky?

ELSS funds don’t have guaranteed returns because they earn from investments in the equity market. The best performing funds have displayed the capability of generating inflation beating returns over the long-term. This is something that fixed income tax saving investments like PPF and FDs cannot do.

Equities tend to be volatile over the short term, but the performance tends to get level out over a longer, three year time frame or sometimes over a five year time frame.

Even the fund manager is not under pressure to take risky aggressive investment calls to deliver short term growth, as investors are in the fund for the long haul.

This makes ELSS less volatile, as compared to that of a diversified equity fund.

Yes, equity-linked savings scheme or ELSS funds are risky. Since these tax-saving mutual funds invest in the stock markets, they come with equity-related risks. If the markets go through a bear phase, even the best ELSS funds can see erosion in the value of their portfolio.

During a bull run, an ordinary ELSS fund will also be able to generate returns, but a bear phase will separate the best from the rest. What a good fund will be able to do is earn well when the going is good and contain the fall when things go bad. But even then, ELSS funds do come with a fair share of risk. Their performance is dependent on the companies they invest in.

Depending on the allocation to various market caps, the risk profile of an ELSS might be different. Funds with higher mid- and small-cap exposure would be riskier than those with a higher proportion of large-cap funds.

Major advantage of the three year lock in period is that it controls the withdrawal of money therefore allowing your investment to grow with the passage of time. And this is an unwritten rule, that long term investments in equities always yields increasing returns as compared to any other investment instrument available.

By compelling the investor to wait for three years, it makes him to take a long term vision of the market, which injects investing order to a definite degree. The actual capacity of a portfolio in generating returns from equities can be realized only if the money stays invested for at least a few years. Moreover if the fund manager knows that the investment would not be withdrawn in the next three years he will be able to plan and formulate a line of attack that will ultimately do good to the investor only

The average three-year SIP returns of ELSS funds for 2017 and 2018 were around 14%, and only 6% in 2019.

Because of the lock-in of three years, fund managers in ELSS funds generally take high exposure to mid- and small-cap stocks, which performed badly in the past two-three years. This has resulted in the poor performance of these funds.

Although ELSS can possibly deliver nil returns, we should not forget that the same product can also deliver 20% pa returns.

If you have found yourself in a bad investment phase, then it is fine. The best advice would be to stay invested and keep accumulating the units in a systematic manner. Most of the time, a monthly SIP or a lump sum investment in ELSS will outperform other tax saving products. The probability of outperformance increases to 80% if the investment is held for at least five years, which to be fair is equally as much as the minimum lock-in period in other tax-saving products like National Savings Certificate, 5-year tax-saver fixed deposits by banks and others.

Over the long term, equity performs best.

The high returns that equity can earn is the first reason to invest in an ELSS fund. Over the long term, which means periods of 5-10 years, equity has largely outperformed investments in fixed income. Many fixed income tax-saving options such as PPF (Public Provident Fund) and FD (Fixed Deposit) give returns in the 5-7 per cent range. This kind of return isn’t going to help you beat inflation. On the other hand, ELSS funds have generated revenue in the range of 12-15% over most 10-year periods. This ensures that not only do you receive higher returns, but your capital invested is also safe from erosion.

Great opportunities come from bad times

For fixed income investments, a downturn in the economy would be a bad signal. They invest in bonds that are heavily dependent on the economy. Of course, even businesses rely on the economy, but a temporary downturn-when stocks of good companies plummet-may turn out to be a great opportunity for investors to buy into the ELSS funds they have. As ELSS funds can invest in good stocks at lower rates, they can produce good returns after the crisis is over and the economy begins to do better. This is why it is recommended to invest in ELSS funds even during a bad period.

Conclusion: Invest in ELSS funds only till 80C limit

A simple analysis shows that performance of ELSS funds is in line with other equity funds and commensurate with their cap exposure. So investors, who have limit left under Section 80C and who want to invest in equity funds, should definitely go ahead and invest in ELSS.

There is no special reason to choose ELSS once you exhaust your sec 80(C) benefit….you can as well invest in normal MFs either in lump sum or once every few months (quarterly, half yearly or annually) or go for SIP…or play the fund manager role yourself by investing in a mix / basket of large, middle and small caps across sectors…