Be Aware: ELSS Mutual Funds Are Just as Risky/Rewarding as Other Funds

Published: January 22, 2017 at 9:39 am

Last Updated on

In the last quarter of the financial year, we are likely to encounter advertisements and sales pitches for how ELSS mutual funds are better than other tax saving instruments. A common sales pitch is that ELSS mutual fund investments are locked for three years and hence the fund manager can deploy funds without worrying about redemption pressure. Some have even suggested that this lock-in will help get better returns.

For those who can put two and two together, ELSS mutual funds come with an upfront commission (now, thankfully) capped at 1%. An ELSS SIP is a nice way to set up a constant commission stream for the intermediary and income stream for the AMC, with each instalment locked in for three years.

I had debunked this “myth” earlier: The Myth About ELSS Fund Lock-in but would like to revisit the topic of a lock-in when I saw this advertisement.

In particular this image:

It is an image of a man enjoying an up close view of a crocodile while sealed up in a cage.

FYI, this is the full picture and the cage is known as er …  “cage of death”!!

Source: https://awol.junkee.com/this-darwin-aquarium-lets-you-swim-with-gigantic-crocodiles/4884

This cage of death is a trip “down under offered by Darwin’s Crocosaurus Cove.

Now let us look at the accompanying statement:

If your investments are locked in, you need not worry about market volatility

What is the implication here? The ELSS lock-in protects the investor from market volatility?

Or is it: Funds with a lock-in have lower market volatility?

Or is it: the money is locked-in, so there is no point in worrying about market volatility? 🙂 (would that sell?!)

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I will leave the interpretation to you and focus on some hard facts.

ELSS mutual funds are not closed ended funds. The entire AUM collected during the NFO period is locked in for the first 3 years.  Many years later, the fund will have a constant stream of inflows and outflows. So even if we assume a lock-in has a benefit (a myth), the AUM is not really locked-in. Investors can rush in to invest and there will always be a trickle of redemptions.

1 ELSS Mutual Funds: Risk vs Reward

The risk measured over a three year period and the return obtained over that period are plotted for all diversified mutual funds (open circles). The ELSS mutual funds are represented by red dots. Notice anything special about them? I cannot. Source: Value Research.

The funds at the higher end of the risk spectrum are mid-cap and small-cap funds

2 Reward: ELSS vs Other Categories

The three-year returns for all categories are shown below (source Value Research). Notice the ELSS funds offer a return quite similar to multi-caps, some mid-caps and a few large caps. Nothing special.

AMCs and their intermediaries are going to sell the way they see fit. It is up to us investors to be informed.

ELSS Mutual Funds Are Just as Risky/Rewarding as Other Diversified Funds

Their only advantage is that they help in saving tax. However, there is no free lunch. This saving comes with a lock-in.

Those who understand the importance of an asset allocation will recognise that there is no need for ELSS mutual funds. EPF, VPF, PPF, mandatory NPS, term insurance premium, or children’s tuition fees or a home loan tax benefit is all that one requires:

Making the best use of section 80C for tax saving: an example

Also see: Do not use ELSS mutual funds to save tax in the last minute!

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Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice.
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7 Comments

  1. What’s your view of ELSS v/s PPF? I have seen somewhere(dont exactly remember on which site) that it is better to invest in ELSS funds than put 1.5L in PPF for the simple reason that you get only 3 yr lock-in v/s 15 years in PPF AND you get better returns than 8.x% in PPF(although not fixed it is still <8%). This has got me thinking since I was always putting my 1.5 straight in PPF religiously every 2nd April.

    Though I am well invested via SIP in Diversified MF but what to understand from the 2 facts given above for ELSS v/s PPF? what according to you should an investor do? Is there some strong benefit that PPF provides(drop protection from court attachment for the time being). Also considering interest rates are on downward trend and PPF is loosing interest for the Govt. to keep giving high interest rates and Equity MF also compound over long term, this is even more pertinent question to ponder over for all.

  2. Sir
    I have read few articles of your where i found you have put some kind of exclamation mark on ELSS funds. From your article it is noticed that you create some kind of fear among people for not investing in ELSS or “be aware of risk etc before investing” like comments!!
    I have a question in my mind, do you really i repeat you really think that there is something better instrument than ELSS for tax savings??? What ever be the reward and risk, can any instrument ever best ELSS in long term??? PPF, Ulip, NPS, LIC policy’s, NSC, KVP, etc all are having a minimum lock in period of 5-8 years!! ELSS in this case is 3 years. What if people instead of redeeming after 3 years, they remain invested for a long term as they remain in case of PPF, Ulip, LIC, NSC, etc. Wont they get higher return than all those instrument???
    The popularity and faith and respect that you have gain, people follow your advice blindly and unconditionally. Instead of making them fear of ELSS you could have written articles for remaining those people invested for longer periods of time for better returns!!
    No way ELSS is inferior than any tax saving instrument. You prove with mathematics.

  3. The article is still not exactly answering my question though it puts up some points in its defense. My query specifically was “assuming all things equal”, is it better to put money in ELSS instead of PPF considering lower lock-in, better returns than PPF due to equity allocation and also assuming that mkts do well and there is no dot com burst scenario.

    Do not expect Govt. to not take interest rates to abnormally low(they have already started in many cases) incase of a mega recession. No Govt. is fool to pay 8+% tax free interest when their coffers are empty and all around is gloom and doom. If Stocks can crash so can fixed income products esp. now that interest rates are not fixed in time but revised periodically mostly on the downside.

    I am not trying to extract an answer I want to hear but trying to see solely from an investment point of view(lets keep fixed/debt invt. v/s equity out of picture for the moment) which one is better incase of a steady and positive environment. I will be glad if you have some statistics to bring out an unbiased comparision.

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