Can tax saving mutual funds help you to achieve your long-term financial goals?

Most mutual fund advisors ask their clients to link their investments in tax-saving mutual funds or ELSS funds to a long-term financial goal.

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Most mutual fund advisors ask their clients to link their investments in tax-saving mutual funds or ELSS funds to a long-term financial goal. They argue that such an approach would help investors to hold on to their ELSS investments for a long period. Many ELSS investors mistakenly believe that they should sell their investments after the mandatory lock-in period of three years. Sadly, some of them spend the money rather than investing the proceeds in an equity scheme. Some investors also invest the money again in an ELSS (known as recycling in mutual fund circles) to claim the tax deduction.

As you know, investments in ELSS funds qualify for tax deduction of up to Rs 1.5 lakh in a financial year under Section 80C of the Income Tax Act. These schemes come with a mandatory lock-in period of three years. However, this doesn't mean that investors must take the money out of these schemes after three years. If the scheme is performing well, investors can continue with these schemes, say advisors.

However, some investors argue that it is better to invest in a regular equity mutual fund scheme with a clear mandate to achieve long-term financial goals. The raises a big question: can you bank on an ELSS to achieve your long-term goals? Are ELSS funds as good as comparable regular mutual fund schemes when it comes to performance or creating wealth for mutual fund investors?


Well, ETMutualFunds.com decided to take a close look. We compared the performance of tax saving funds with multi cap funds as most ELSS funds are managed like multi cap schemes. In other words, they do not have specific mandate to invest in any particular market cap. These schemes follow multi cap style of investing which makes them comparable to multi cap category. We decided on a quick comparison of the performance of ELSS funds and multi cap funds in three-, five- and seven-year periods.

Why these three investment horizon. One, since they have a lock-in period of three years, we thought we should look at their performance for the three-year period. Two, since mutual fund advisors ask investors to invest in equity mutual funds, including ELSS funds, with a a minimum investment horizon of five to seven years, we decided to include these two horizons as well.

To check the performance, we have used rolling returns for the above mentioned time periods over a period of 15 years. Rolling return is the average of a series of returns over a long period of time. It is like a daily SIP for a certain interval and then taking an average of the series of returns.

To understand rolling returns, read: Which is the best way to measure performance of a mutual funds
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The results of the study did not surprise us. ELSS and multi cap funds performed on similar lines for all the three time periods under consideration. The table below will make it clearer.

Rolling returns* (%)
3-year 5-year 7-year
ELSS 16.29 16.47 15.38
Multi cap funds 16.39 16.86 15.78
*Rolling returns calculated over a period of 15 years. Returns are mean of rolling returns of all the schemes in the category for the specified time periods.
Source: Ace MF

The data makes it clear that ELSS category can indeed help you to meet your long-term goals. If you can take moderate risk, you can either buy an ELSS or multi cap scheme to achieve your long-term financial goal. If you are buying an ELSS, you can claim a tax deduction on your investment.

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