Is Arbitrary Investment in Tax-Saving ELSS MF Scheme Just Before the Year End Justified?

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As the close of financial Year 2009-10 nears by, the inflows into Equity-Linked Savings Scheme (ELSS) is gaining its ground over other mutual fund schemes for the sheer benefit of tax-saving advantage that these schemes offer to its investors. In fact, since last one month, the record inflow of retail funds in to such ELSS schemes is gradually over-powering the inflows in some of the more well-known diversified equity schemes of various fund houses.

ELSS Tax Schemes

Claiming Tax-benefit

Under the prevailing set of law, investors can invest up to Rs.1 lakh in ELSS schemes to avail of tax exemptions under Section 80C. However, an investment under this special tax benefit scheme comes with the rider of minimum lock-in period of three years for its investors.

Undergoing Proper Due-diligence

A prudent investment practice would involve investing in any asset class with a proper planning and reasonable due-diligence. Like, for example, an investor in real-estate property would check out certain aspects like price per square feet, location of the premises, amenities provided in the premises, etc. before investing his money.

Similarly, an investor in a direct equity market would check out on certain company fundamentals, valuations, management quality, etc before investing the same hard earned money. So, how is arbitrary investment in tax-saving ELSS schemes without any proper due-diligence justified simply because the financial year is approaching its last month?

At the end of the day, even the ELSS schemes are going to invest a major part of its inflows in to equity. What if the stock market valuations are expensive at the time of arbitrary investment made during the year end horizon?

Take, for example, those investors who arbitrarily invested during January and February of 2008 at which time the benchmark index Sensex was hovering around 19-20k. Eventually, stock markets went in to a major bear market for next 2 years since then. The then investors who invested arbitrarily at the market peaks for the sole purpose of tax-saving benefit are still bleeding to date even as we witness doubling of stock markets from their lows of recent slow down. Reason being Sensex is still way below 19-20k and those levels of high NAV is still awaited.

Staggered Approach to Investment

So this indicates the significance of thumb rule regarding proper due-diligence and analysis being applicable to all types of asset-class including ELSS tax-saving schemes. A better approach would be to make use of ELSS schemes, just as SIP works for Diversified Mutual fund schemes, in form of staggered approach to investing during the course of whole year rather than arbitrary investment in lump sump amount at the end of the financial year.

The arbitrary investment would mean betting your entire amount of investment with respect to market levels on that particular date rather than continuous process of investing in staggered manner and taking benefit of all the market ups and downs. This could prove fatal when markets are at the higher price curve; eventually it may lead to lower or no yields at all, at the end of the 3 year lock-in period. This nullifies the investment objective which gets sacrificed for the sole purpose of tax-saving benefit through ELSS schemes.

ELSS vs. Diversified MF

Investors might argue, in that case, the investment perspective is more elegantly met by investing directly in diversified equity schemes itself, if SIP is the approach that is recommended for better yields and returns. I would say, ELSS schemes come with an added advantage of 3 year lock-in period which gives the fund manager an extra elbow room of 3 year investment perspective, unlike diversified funds, where stability with respect to fund outflow is more controlled and capped during times of down turn. From this perspective, ELSS schemes are no less lucrative an offer vis-à-vis other equity schemes when used in a staggered approach of investing regularly. Having said that, once all this is factored in, the final yields does cling on various other aspects too like fund house policy, fund manager quality, past performance, etc.

Were you about to invest your lump sump amount in ELSS scheme in next few days? Don’t you agree to debate of a planned approach to investing for your hard earned money?

Arun’s Note: We are nearing the Financial Year end, and most of us are working on how to save taxes. Hence, over next few days we will be featuring series of posts on personal Finance and Investments that may help readers to make informed decisions on their Taxes and Finance. Request to readers – If you have any specific questions, do not hesitate to drop us a line. We will do our best to try and help you out !

  1. Viral says

    Dear Raj,

    Thanks for throwing light on the ‘Dividend’ perspective of Funds. However, there is a caveat with this regard too. No doubt, an investor can redeem some part of his investment by timing his investment in order to receive dividend from some of these funds. But, the NAV of that fund will be reduced to the extent of dividend announcement, which may, in turn, mean a dip in your investment sum when aggregated from NAV and Units you hold.

    The net effect won’t be of too much difference, as ‘dividend’ is nothing but distribution of the profits and that would mean reduction in NAV to that extent. Thanks for your informative comment.

  2. Raj says

    Hello Viral,

    Very informative article indeed. I would like to say that there are some advantages of lumpsum investment into ELSS too, especially in months of Jan-Feb-mar as most of the funds give dividends in these months so if one is investing say 50K in the same and the fund declares a dividend to the tune of 5K then effectively one has got the advantage of claiming rebate on 50K with investment of only 45 K. But again, this may not happen with all of the funds. Secondly, the lockin of lumpsum is 3 years but for SIP each SIP has to be effective for 3 years so eventually lockin turns out to be for 4 years, for 12 month SIP and the chances of fund or market performing bad in that 4th Year could be high too.

    Thanks.

  3. Viral says

    Dear Ankit,

    Most people share with your story. But, I hope you’re aware that ULIPs are for real long term investments as against any other investments linked with equity. ULIP schemes bear heavier costs durign initial period and more light on the pocket of the investors in the subsequent years. So, it is advisable to hold on to ULIPs for more than 5 years, preferably for its entire tenure of period, to reap maximum benefits in form of health cover & capital appreciation both. Or else, ELSS is always better if your time horizon for holding your investments is 3-5 years.

    Not many have courage of raising both their hands like you did in above comment. This shows you’re a quick learner & you can move on with it in future. Thanks for your valuable comment.

  4. Ankit Agarwal says

    Both Hands Raised!! I have been a culprit of it twice now.Invested last minute in a ULIP last year without even checking the performance.
    This year round, did not want to invest for saving tax.thought i can make more money by investing in the secondary market without blocking my money for 3-5 years.But, then peer and family pressure brainwashed me.

    re-invested in last year’s ULIP.A bad decision but i have heard that regular investment in the same ULIP can help redeem the damage done in the first place :-)
    But, reinvested half in a tax saver ELSS from BNP Paribas.The folks have shown tremendous potential in the past few years, so thought it is better to go with a trusted performer.
    Add to the misery, i am yet to receive the receipt and could not file the ELSS investment in the Form-C :-(

  5. Nikhil Ambekar says

    Most of the people doing last minute investments are only looking to save tax hence overlook the angel of actual investment.People generally tend to choose Tax saving MFs because there is a feeling that Investment in MFs in safeguarded so very few people study the performance of the MF and Market situation.

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