Does it make sense to continue with ELSS now?

Let us understand how should we evaluate the ELSS scheme in the new tax regime.

Feb 26, 2020 11:02 IST India Infoline News Service

A day after the Union Budget 2020 was announced by the Finance Minister, fund managers and financial advisors were worried. The budget had proposed a new tax regime where taxpayers will be charged a lower rate of tax but a total of 70 out of 100 exemptions would be withdrawn. Section 80C was also to be forfeited in the new regime. 

Why is Section 80C so important?

Currently, Section 80C offers exemption up to Rs150,000 for investments like CPF, PPF, ELSS, ULIPs, tuition fees, etc. One real advantage of Section 80C was that it was forced savings. In the last few years, equity linked savings schemes (ELSS) had become extremely popular because they created wealth, had a low lock-in period of 3 years and instilled a long term approach in fund managers.
 
ELSS had become very popular among the millennials and young earning people as they found this indirect exposure to equity quite attractive. Also, since the exemption under Section 80C was an upfront benefit, it reduced the cost of acquisition of an ELSS fund and enhanced ROI. But how do we evaluate the ELSS scheme in the new tax regime? 

Do ELSS funds really have a performance edge?

One can argue in favour of ELSS Funds if the returns are really better than comparable equity funds. We consider the 1-year, 3-year and 5-year returns of ELSS funds, large cap funds and multi-cap funds.
Fund Name 1-Year Returns 3-Year Returns 5-Year Returns
ELSS Funds (Growth Option Regular Plans)
MOSL Long Term Equity 23.033% 11.479% 12.869%
Axis Long Term Equity 26.303% 16.687% 11.157%
Tata India Tax Saving 16.864% 11.720% 10.501%
Large Cap Funds (Growth Option Regular Plans)
Axis Blue Chip Fund 23.961% 18.844% 10.859%
Mirae Asset Large Cap 14.279% 12.403% 10.395%
Canara Robeco Blue Chip 22.723% 14.183% 9.266%
Multi Cap Funds (Growth Option Regular Plans)
MOSL Multi-Cap 35 14.879% 8.899% 10.631%
Kotak Standard Multicap 18.347% 11.811% 10.031%
SBI Magnum Multicap 17.735% 10.304% 9.963%
Data Source: Morningstar
 
In all  the three fund categories, there are outliers in performance. However, if you leave out the odd outlier, there appears to be a pattern in the performance of these funds. Most of the funds have done very well over a one year period but that is not a good benchmark since ELSS has a mandatory lock-in of 3 years. If you look at a 3-year or a 5-year time frame, there is no real performance advantage you can see in the ELSS funds as compared to large cap funds or multi-cap funds. Hence, if you are not claiming the exemptions under Section 80C, then the most important trigger for ELSS returns is not there and hence may not really add value. They would be better off sticking to large cap funds or multi-cap funds, where there is no lock in prescribed.

What if you are sticking to the old regime of taxation?

If you stick to the old regime of taxation, then ELSS continues to be the best option for you. The lock-in period is just 3 years compared to a minimum of 5 years for other products; going all the way to 15 years for PPF. Also, the ELSS is a form of mandatory wealth creation imitative where the 3-year lock-in works in favour of equity returns. The tax break, even assuming that you are in the 20% bracket, can substantially enhance your effective post tax yields on the ELSS investment. So, if you are sticking to the old tax regime, then ELSS must be a part of your portfolio.

What about ELSS plans commenced and ELSS plans matured?

Clearly, for the old regime, the ELSS plan makes a lot of sense. But there is a more pertinent question. What should investors shifting to the new regime do with existing plans or with ELSS plans that have already matured (completed 3 years since commencement)?
  • If you are shifting to the new regime, then you can stop fresh contributions to the ELSS plan. This is specifically if you are doing a SIP on your ELSS plan as each SIP contribution will be locked in for a period of 3 years from the date of investment.
  • If your ELSS has already completed 3 years, then it is as good as any equity fund and so you don’t need to worry. Don’t be in a hurry to exit the fund if it is performing well. Since your money is not locked in anyways, you can as well ride the storm.
 
ELSS continues to be a solid product if you need to save tax. However, in the new regime, you may be better off saving in a diversified equity fund or a multi cap fund.

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