How much are you investing in ELSS? - Views on News from Equitymaster

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How much are you investing in ELSS?

Apr 6, 2005

Amongst the various announcements made by the present government, there have been a number of positive moves pertaining to the stock markets also, which are aimed at increasing the retail participation. One such announcement was that of the government removing the Section 88 benefits to the taxpayer. Instead, taxpayers have now been allowed a consolidated limit of Rs 1 lakh for savings as deduction from the income before tax. This Rs 1 lakh will include the provisions of pension U/S 80 CCC, the tax mutual funds (MFs) (ELSS), government bonds, pension funds, provident funds and insurance policies etc. without any specified demarcation. The important point here is the inclusion of the words 'tax mutual funds', which are also known as 'Equity Linked Savings Schemes (ELSS)'. Thus, now that we are into the new fiscal and the new laws are applicable, we decided to find out from the Equitymaster audience whether the government's attempt will be successful in generating higher retail participation in the markets through the ELSS route. In the above backdrop, we conducted a poll on our website wherein we asked, 'How much of the Rs 1 lakh limit would you invest in MFs (ELSS)?' The results are depicted in the chart below wherein all the options have managed to garner almost an equal amount of votes. So is this a sign of success or retail participation will still take some time?

Well, we must say that undoubtedly, the Finance Minister's move is a welcome step for the stockmarkets and will go a long way in helping increase the retail participation in the markets. However, while there can be no 'one-for-all' type of an investment model for investors, by conducting this poll, our primary intention was to get across the importance of asset allocation.

Whatever portion of the Rs 1 lakh limit may the investor allot towards equities, before making investment decisions, the importance of asset allocation must be given its due importance. This is because, the 'close-to-optimum' portfolio model for any investor would depend on various factors like age profile, expected returns, investment time horizon, risk appetite, etc. On the basis of these parameters, the proportion that could be allotted to equities would be decided.

For instance, the risk appetite of a 25 year old person with limited responsibilities would be higher as compared to a 40-year-old working executive who would have a family to support, which in turn would be higher than a 55-year old person who is nearing retirement and for whom preservation of capital is of utmost importance. For the former (youngest), the equity component is likely to be on the higher side and for the later (eldest), real estate, fixed deposits and cash component would be proportionately higher. While there is no thumb-rule as to the proportion of investment in equities, the formula: 100 less your age is a good enough indicator of the proportionate amount that could be invested in equities.

Thus, for the 25-year old, the equity component would hover around 75% (100 minus 25) whereas for the 40-year old person it would be 60% (100 minus 40) and so on. However, we must re-iterate that this is not the only parameter that has to be kept in mind and all the other parameters mentioned will have a significant bearing on the final proportion invested in equities.

Now, if a retail investor, after determining the asset allocation component, decides to invest in equities, the next question would be, where and which companies should he invest in? Returns from equities, broadly speaking, are comparatively higher than all other investment avenues. And so are risks of investing in equities. Equities are generally subject to various risks like market risk, business risk, interest rate risks and so on. However, to mitigate most of these risks, the best way is to invest with a long-term investment horizon and invest in a staggered manner. While currently the markets may seem euphoric, it must be noted that the biggest reason for the same has been the money poured in by the Foreign Institutional Investors (FIIs), the fate of which hinges largely on US interest rates. Though we are not trying to be doomsayers' here, we believe that it is better to exercise caution. Over the long-term, sound fundamental based investments bear reasonable returns.

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