Will investing in ELSS during sharp market falls offer more returns?

Millennial investors are beginning to see the merits of this product which combines tax efficiency with wealth creation. When the ELSS is executed through a SIP, it also gives the added advantage of rupee cost averaging and synchronising with inflows.

Sep 13, 2019 05:09 IST India Infoline News Service

Equity Linked Savings Scheme
Equity linked savings schemes (ELSS) have emerged as a veritable tax saving tool for Indian investors. Millennial investors are beginning to see the merits of this product which combines tax efficiency with wealth creation. When the ELSS is executed through a SIP, it also gives the added advantage of rupee cost averaging and synchronising with inflows. These advantages surely make ELSS attractive but there are two questions that arise. Firstly, how does the tax break add value to the investor? Secondly, should ELSS be timed closer to the bottom of the market?
 
How the tax advantages of the ELSS work out?
To understand the tax benefit of an ELSS and its impact on yield, let us compare a pure equity fund with an ELSS fund. Both are structurally the same except that the ELSS has a 3-year mandatory lock-in and offers exemption under the overall limit of Rs150,000 under Section 80C of the Income Tax Act.
Equity Fund Amount ELSS Fund Amount
Initial investment Rs100,000 Initial investment Rs100,000
Value at the end of 3 yrs Rs155,000 Value at the end of 3 yrs Rs155,000
Tenure of holding 3 years Tenure of holding 3 years
CAGR Yield 15.73% CAGR Yield 15.73%
Section 80C Benefit Nil Section 80C Benefit 20%
Effective Investment Rs100,000 Effective Investment Rs80,000
Post tax yield CAGR 15.73% Post tax yield CAGR 24.67%
 
The above illustration best captures the impact of the tax benefit on the ELSS fund. In the above case we have only considered 20% tax impact and that has given an advantage of nearly 900 bps in CAGR yield to the ELSS fund. If the individual is at 30% tax bracket then the difference will be still higher. The moral of the story is that the tax benefit reduces your effective initial investment and enhances yield. But this yield is subject to the cap of Rs150,000 for all Section 80C investments put together.
 
Should you try timing the entry into ELSS funds?
That is a common question that a lot of us contend with. Should you just follow a passive ELSS SIP approach or should you start a SIP at the bottom of the market or should you invest lump sum at the bottom of the market. Optically, buying lump sum at the bottom should be the best choice but that leaves you with two additional questions. How do you identify the bottom of the market, when the best of experts find it hard? Secondly, if you buy after a sharp correction and the NAV goes lower by 20% then you are stuck for the next 3 years. That way the SIP should be a better choice compared to lump sum investing as it gives the benefit of rupee cost averaging.
 
That brings us to the second part of the problem; should you try and time your entry into an ELSS fund. Let us look at 3 distinct scenarios to answer this question:
  • Investor starts ELSS SIP at the previous top in Jan-07 and continues till date
  • Investor starts ELSS SIP at the long term bottom in Mar-09 and continues till date
  • Investor starts ELSS SIP at the recent bottom of Sep 2013 and held till date
 
We have simulated these 3 scenarios for ICICI Pru Long Term Equity (Tax Saving) Fund and the findings are fairly interesting.
Scenario 1 Details Scenario 2 Details Scenario 3 Details
Start Date Jan-07 Start Date Mar-09 Start Date Sep-13
End Date Aug-19 End Date Aug-19 End Date Aug-19
Monthly SIP Rs10,000 Monthly SIP Rs10,000 Monthly SIP Rs10,000
Investment Rs15.20 lakhs Investment Rs.2.60 lakhs Investment Rs7.20 lakhs
Final Value Rs36.07 lakhs Final Value Rs25.19 lakhs Final Value Rs9.37 lakhs
CAGR Returns 12.77% CAGR Returns 12.56% CAGR Returns 8.63%
 
The findings of the above table are quite surprising to say the least. Here are the key takeaways.
  • Over longer time frame, timing the SIP hardly makes any difference. Over the last 12 years, you would have done slightly better if you had started at the top than at the bottom. This is despite the fact that between Jan 2007 and March 2009, the Nifty had corrected more than 50%. That goes to show that timing hardly makes an impact in the long run. 
  • More than timing the market, it is time in the market that matters. That becomes clear when you consider Scenario 3. In this case, even though you started the SIP at the recent bottom of September 2013, you end up with just 8.63% annualized returns. You would have been better of just letting time work for you.
 Starting the ELSS in SIP form and sustaining it is more important than timing your entry. Focus on time more than timing. 

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