Tips on how to save tax when market is in red

Equity Linked Savings Schemes or ELSS found a lot of takers when the stock market was performing well. On one hand, they saved tax and on the other, they gave handsome returns. But now when the market has dipped significantly and net asset values are in red, should you still invest in them? Yes, it is a good idea. Here's why -

Past trend is encouraging

Data (see table 1) shows that investments in ELSS during market lows are likely to give good returns in the long term. During the period from February 2000 to September 2001, the Sensex fell from a level of 5,934 to a low of 2,600 - a whopping 56 per cent correction.

If you had invested during September 2001, you would have made some decent profits today, considering the Sensex is hovering at 9000 levels (even after the crash from 21000!).

Table 1: Returns on investments made in October 2001

Fund Name (ELSS) Returns(%YoY)

3 yr 5 yr

• Birla Tax Plan 98 58.78 34.18
• HDFC Long Term Advantage (G) 70.79 -
• HDFC Taxsaver (G) 57.15 55.55
• ICICI Prudential Tax Plan (G) 58.27 34.92

Source: NJ India; Returns dated: September, 2004; *YoY – Year on Year

Since the above returns are compounded, the gain is significant. A compounded return of 50 per cent over three years means that in these three years, your money will grow by 3.3 times.

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Equities have delivered in the long term

Table 2 shows that a 3 to 5 year investment horizon helps reduce risk (probability of loss) and also deliver stable returns. The longer the holding, the lower the probability of loss.

Interpreting the table: If you had invested in the BSE Sensex for any one-year time frame (in the last 29 years), 19 times out of 29, you would have made a profit while 10 times, you would have made a loss. If you made a profit, your average profit would have been 27.57 per cent.

Similarly, if you had invested in the BSE Sensex for any 3-year time frame (in the last 29 years), 22 times out of 27 you would have made a profit.

What does this mean: If you invest in equities with a 15 year time frame, the probability of making loss would be ‘nil’. But if your time frame is low, say less than 5 years, then equity may not be the place for you.

Table 2: Probability of getting negative returns

1 yr 3 yr 5 yr 7 yr 10 yr 15yr

No. of times invested 29 27 25 23 20 15

Probability of making profit 19 22 22 20 19 15

Probability of making loss 10 5 3 3 1 0

Avg returns 27.75%20.46%18.78% 17.62%26.20%17.52%

Source: BSE India; Data for year ending March (Every Yr)

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Should you invest in ELSS instead of other investments under section 80C?

Equity investments by nature are prone to relatively higher risk compared to other investments allowed Under Section 80C. So, choose ELSS if:

1. You have a risk appetite for equities

2. If you have a long term horizon

How to choose an ELSS?

Deciding to invest may not be as tough as choosing the fund itself! These pointers will help you make that choice:

• See how the fund has performed over the last 5 years. Check if the returns have been consistent
• Compare the returns with the performance of the benchmark. For example, if you are investing in an equity diversified fund, the benchmark to compare would be the BSE Sensex. Read the fund report card that the fund house sends you to find out the benchmark returns.
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• - Also compare how the fund is performing as against other peer funds.
• Size/expertise of mutual fund house.
• Entry/exit load structure

In addition to the above, a lot of information is available on the internet; it should help you in making a decision. But be prudent in choosing the relevant information only. It's better to be informed than being caught up with a wrong fund.

What should you do with your existing ELSS?

If you have invested in ELSS and not completed the 3 year lock in period

If you already have existing ELSS funds then you should continue to stay invested. If you need the money, you can probably withdraw when the market begins to perform well. However, if you withdraw before 3 years, you will have to bear an exit load.

If you have invested in ELSS and it has completed the 3 year lock in period

If your ELSS is maturing this year leave it untouched; exit when the market scales up. Since equity markets do not move in a linear way, you should book profits when markets are doing well. Systematic investment planning (SIP) is an ideal way to invest.

End note:

Even if the market is not performing too well, it pays to be disciplined and stick around. Even in today's scenario, ELSS is still an attractive option because of the lower lock-in period of three year and the potential returns in the long run compared to other investments. But study your risk appetite and goals before investing.

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