The new tax regime proposed in Budget 2020 has lowered tax rates but restricts taxpayers from claiming tax deductions under Section 80C and other specified sections of the Income-tax Act, 1961. The equity-linked savings scheme (ELSS) is one of the products that are eligible for deduction under Section 80C under the old tax regime. For many investors, ELSS was the first equity mutual fund product that they invested in. With the tax benefits on these now becoming optional, does it still make sense for investors to include ELSS in their portfolios? Sunita Abraham asks experts what investors should do.
Managing director, Axis Mutual Fund
The objective of ELSS is to create wealth over long term
Equity investing is meant for the long term. That’s because equity markets tend to be extremely volatile in the short term—share prices jump around a lot. However, in the longer term, the fundamentals win and long-term equity returns are generally stable.
Historically, ELSS schemes have done well as fund managers invest in the businesses and stocks with a three- to five-year horizon.
ELSS are multi-cap funds with an objective to create wealth for long-term goals. Investors should treat them like any other equity fund, irrespective of whether they opt for the new or old tax regime. People should continue to invest in ELSS, as withdrawing money before the completion of the lock-in of three years is not possible, and investments in equity funds should be for the long term. It should also be noted that once the lock-in gets over, ELSS operates just like any other open-ended fund, and investors are free to redeem whenever they wish to.
By taking out money, investors may end up paying a big price in terms of missing out on the potential for returns through equity market participation.
Executive director, SBI Mutual Fund
ELSS helps instil the discipline investing in equity requires
Changes in the personal tax slabs were aimed to put more money in the hands of the common man. Lower tax rates also meant that a large number of 80C tax-saving options became a matter of choice rather than a need for those in the revised tax slabs.
Save before you spend is an important mantra which has to be imbibed from an early age and I have always believed that disciplined investing helps in long-term wealth creation. While one may ask what is the need for ELSS anymore, it doesn’t change the basic tenet of using ELSS as your equity investment to build long-term wealth. Besides giving tax benefits, ELSS also instilled the discipline of having your investment locked in for three years. So investors should look at ELSS as more than a tax-saving tool.
In fact, a lot of ELSS investors invest in the fund more because it is an equity investment, rather than to avail tax benefit. Starting a SIP is one of the simplest and most effective ways of investing. I would advise them to retain the good habit of investing and continue their journey towards achieving their financial goals.
CEO and principal adviser, Finscholarz Wealth Managers
Invest in other equity funds, rather than locking money
The basic premise for investing in an asset class or a financial instrument should always be decided by asking yourself three questions. First, is the instrument suitable in the overall scheme of investment? Second, can the investor tolerate risk associated with the instrument? Third, what is the net return (net of taxes and expenses)?
If the overall plan requires investments to be made in equity, and if the investor chooses to remain in the old tax regime, ELSS continues to be the best option. If the client chooses to be in the new tax regime, it is better to invest in other equity funds rather than locking the money in ELSS. There are more options and better suitability in non-ELSS schemes. If there is no need for equity allocation in the portfolio, ELSS should not be considered at all, whether the 80C benefit is available or not.
The existing investments in ELSS, which have not yet completed three years, will have to be continued till the completion of the lock-in period. If there is a SIP in ELSS, investigate its suitability based on the above factors.
It was a nudge for young earners to consider equity
ELSS is popular as an investment with young taxpayers and first-time investors especially for the tax breaks they offer, though it’s true value might be to convert the young ones into long-term equity investors.
The three-year lock-in period protects against the behavioural gap or the tendency of retail investors to transact too much. This forced inaction teaches patience which is incredibly valuable in investing.
Having said that, the “nudge” to invest in ELSS is still driven by the tax deduction benefit under Section 80C. That’s what leads the young earner to consider it in the first place.
However, now taxpayers will calculate their tax outlays with and without deductions and if ELSS investing does not lead to a better tax outcome, they may not invest in it. This is just human behaviour—we react to near-term explicit benefits like tax savings rather than long-term hidden ones like better lifetime wealth. Thus, we expect ELSS inflows to slow down due to the new taxation rules, and a lot of taxpayers may never discover the rewards of investing in the equity markets.