The Equity Linked Savings Scheme (ELSS) has long established itself as one of the most preferred forms of tax saving instruments in India. Due to some additional benefits such as lower tax gains, compounding power, better risk-adjusted returns, availability of SIP and lump-sum options, ELSS mutual funds offer the opportunity to generate reasonable returns while saving on tax. Talk about striking goals with just one investment! Investors are aware that ELSS schemes have a lock-in period of three years. However, most of them do not know what to do with the earnings after the lock period ends.
Should they continue to stay invested in the scheme or redeem their portfolio? In order to properly answer this question, let’s analyze what is the right holding period for equity investments.
Equity investing is designed for the long term. Depending on who you ask, the definition of long term varies. But the general consensus is three years or more. This is because stock markets tend to be extremely volatile in the short term, meaning stock prices jump a lot.
However, over the longer term, fundamentals prevail and long-term equity returns are remarkably stable. In fact, markets have been said to be like a short-term beauty contest and a long-term balance. This dissonance tends to confuse investors and leads them to make sub-optimal choices. Therefore, investors should be very careful and ideally avoid allocating money to equity markets in the short term. Longer investment horizons also allow the benefits of ‘capitalization’ to accumulate.
However, what is the correct definition of long and short term? It is tied to earnings and the economic cycle as well as changes in sentiment in the market. Businesses usually do not grow in a straight line, but growth tends to be more erratic due to various internal and external reasons such as seasonality, product launch cycles, etc.
These tendencies tend to be established only over time. In the short term, analysts studying these companies can only work with the best estimates. However, different analysts may have different estimates. Also, as new data comes in, these estimates may change.
Therefore, there is a large margin of error when evaluating a short-term stock. This is the reason for the volatility of the underlying price in the short term from a fundamental point of view.
This volatility is further compounded by shifts in investor sentiment. When we are in a bullish environment, for the same security, a higher valuation seems acceptable, while bearish periods call for much lower valuations.
In light of all of this, the long term for equity investing is anything that takes the uncertainty out of growth cycles and sentiment cycles. And looking at the history, this only happens when you’ve been investing for well over 5 years – maybe even 7-10+ years.
Yes, you can get lucky and get good returns in the short term, but you need to make sure you’re allocating for the long term in order to consistently participate in the potential of the market. With reference to this we get the answer to our question. Obviously, it is not optimal to leave ELSS after the 3-year lockdown expires.
Ultimately, ELSS funds invest in stock markets, and to do them justice, investors should be prepared to stay invested much longer.
It should also be noted that once the lockdown is over, ELSS funds operate like any other open-ended fund in that investors are free to redeem any day they choose. Therefore, there is no special advance for redemption at the end of the lock-up and instead the investor may pay a high price in terms of missing out on potential equity market participation. Time invested in the market is more important than market timing in taking advantage of long-term wealth-building opportunities.
Jinesh Gopani is Head of Equity at Axis Mutual Fund.
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