New tax regime is here. Time to stop your ELSS investments?

ELSS (Equity-Linked Savings Scheme) funds, also known as tax-saving mutual funds, is having its Kodak moment. Just like the advent of digital photography was a kiss of death for Kodak's decades-old film-based business model, ELSS funds have been in the midst of a severe existential crisis due to the Indian government's tacit phasing away of the old tax regime.

Sure, while Kodak's downfall was due its own handiwork of not moving with time, ELSS funds' shine has dulled due to external factors, namely New Delhi making the new tax regime to be a better option for a majority of Indian taxpayers.

So, what do existing ELSS investors do, especially if they have completed their mandatory three-year lock-in period? Should they liquidate their investments and look for greener pastures?

This is where cold, hard data can help you make a decision.

How have ELSS funds performed in the past?

• Over any three‐year period (in the last decade), ELSS funds have delivered an average of 14.24 per cent returns per annum. The minimum three-year annualised return was -7.2 per cent.
  
• When we extend our view to five years, the average annualised returns came to around 13 per cent and the minimum return was -2.12 per cent, which is better than over any three-year period.
  
• Stretch the investment horizon to seven years and the average annualised returns remain around 13 per cent, while the minimum was a 7.23 per cent.

This shows that the longer we stay invested in an ELSS fund, the better risk-adjusted returns we are expected to earn.

How ELSS funds compare to flexi-cap funds

For all practical purposes—except for the three-year lock-in period and tax benefits—ELSS funds are as good as any other diversified equity funds like flexi-cap funds to build long-term wealth. Like them, ELSS funds have the flexibility to invest across companies of different sizes and sectors, providing you with diversified exposure.

So, if we were to compare an average ELSS fund's performance with an average flexi-cap fund, you'd see them both churning out similar returns. Both categories gunned out an annualised return of 13 per cent on a five- and seven-year basis. Hence, sticking to either option is conducive for long-term wealth building.

So, should you stick or twist with ELSS investments?

This is for those whose ELSS investments have crossed the three-year lock-in barrier.

If you need money or have reached your investment goal, it may make sense to withdraw your money from the ELSS fund.

If you do not require immediate funds, staying invested might be the best course of action. Extending your investment horizon—say, to five, seven or even ten years—can help you benefit from market cycles and the power of compounding. The data mentioned above clearly shows that longer holding periods have historically resulted in higher yields.

If you are not happy with your fund's performance, a data-driven evaluation is essential. Start by comparing your fund's rolling returns with other ELSS funds (or flexi-cap funds if you don't have tax considerations). Additionally, assess its performance against the BSE 500, which is the benchmark for diversified funds like ELSS and flexi-cap funds.

You can also look at your ELSS fund's historical performance across different market cycles.

Doing this simple analysis will help you determine how your ELSS fund is performing.

If it is consistently underperforming for two to three years, you may switch to another diversified fund.

What you should do with your active ELSS fund

For those with ongoing SIPs in ELSS, it is worth reassessing your strategy. With the new tax regime reducing the emphasis on upfront tax benefits, you might consider redirecting your SIPs into a flexi-cap fund. These funds offer similar diversification and long-term growth potential while potentially aligning better with your current financial goals.

However, if you tend to make impulsive investment decisions, sticking with ELSS might provide a useful safety net. The three‐year lock‐in acts as a natural discipline mechanism, helping to prevent hasty moves that can disrupt your long-term investment plan.

Ultimately, whether you choose to redeem your investment, continue holding it or reallocate your SIPs, your decision should be guided by both your overall financial objectives and robust performance data.

Also read: Small-cap mutual funds are down 13 per cent. Should you halt, continue or increase your SIPs?