A software professional friend of mine, Vinay Khanna, received a communication from his accounts department to furnish proof of investments made for tax saving during the year. And so, the scramble began. If he fails to submit documents to show adequate investments in tax saving schemes, he will see taxes being deducted from his salary for almost three months to March. 

Khanna is not alone. This story holds for many like him. 

Besides the traditional government run saving schemes like public provident fund or national pension scheme, Vinay will also allocate some money to equity-linked tax savings schemes. 

Where does the problem lie?

When you allocate money to an equity-linked tax saving scheme at the last minute, you are doing it to meet your tax obligations. 

But remember: This is different from investing. When you invest, you do it for capital appreciation. Here, you are doing it because you have to submit some documentary proof to your employer. 

There’s a downside to this: You are unlikely to benefit from the change in prices over time. It is fine if you invest in a lump-sum when stock prices are low. But it will not be so good if you buy when share prices are at their peak and they go down later. You will keep wondering what hit your investments.

Instead, if you spread out your tax-saving investments throughout the year, you might benefit from the change in prices. When the share prices are low, you may buy more. If the prices are high, you may buy less. This way, your average investment cost reduces. 

Understanding ELSS right

If you look at any research data that calculates returns of various equity-linked mutual funds during multiple time intervals, (for six months, one year, three years or five years), ELSS schemes usually outperform their benchmark indices. They have the potential to provide probable returns than any other open-ended sectoral, large cap or mid-cap funds equity schemes in the long run. The return calculated does not include the tax benefit you get as a result of investing in the scheme under section 80C of the Income Tax Act. Meaning, the actual monetary benefit is not definite. 

Why the difference?

Mutual fund managers often buy or sell stocks depending on their research. Whenever stock markets witness volatility, mutual fund investors tend to either buy more or redeem their units. When the redemption pressure or selling of units by investors intensifies, fund managers are forced to sell their stock holding and ensure adequate cash to manage investor payouts. This results in the net asset value or NAV of these schemes to fluctuate. However, the story is a bit different for tax saving equity schemes. It is not possible for unit holders of tax saving schemes to redeem units due to the lock-in period. The redemption pressure is low on tax saving schemes in a falling market than open-ended equity schemes. Hence, the performance of ELSS schemes is relatively less volatile than open-ended equity schemes. 

What should investors do?

Investors should get the right mix of both. A change of mindset is critical here. ELSS schemes are one of the ways to buy into for long-term capital appreciation. They are not just tax saving instruments. At the beginning of the financial year, you can decide on your overall allocation to equity funds and incorporate both open-ended equity schemes and ELSS schemes. That way, you would not have to scramble for tax saving instruments at the end of the year. Your regular investments would help you to take care of your future as well as your tax needs.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.