ELSS as a Nudge for Long Term Investing
I buy my requirement of ELSS every year in March. One Lump-sum into a fund I have chosen. While I spend time selecting that fund despite knowing that I may not be buying what would have been the best 3 years from now, the analysis and the results thereafter provide me with a deeper understanding of how to avoid mistakes.
Here are the top ELSS funds from that day onwards. Not bad, Right :). Then again, the second and third rank funds are nowhere in the top performing funds. Maybe add a large element of Luck as well.
While most of us use ELSS for tax savings only, a very good friend of mine invests in ELSS not for tax saving but more as an allocation to Equities. Why lock up one’s money unnecessarily you may think and you would be right. ELSS funds are locked with no exit for 3 years while with normal funds, you can get out any day you want. Some funds have an exit load, but exit is possible.
In one of his most influential book, Nudge, Author Richard Thaler says, one needs to resist temptation. Then again, while we think we can resist the temptations when the times are good and the mind is cool, when we are actually faced with decision making, we fall prey to the easy way.
Take for instance the concept of “Mental Stop Loss”. Many traders believe that if they place a stop loss on the terminal, it will be sought out by Algo’s or Operators and executed. Why not keep the same stop loss but one in the mind and execute when price breaches the pre-decided level.
Its sound in theory other than the fact of operators deciding that your stop is worth moving the Index a few points. But what happens when the price actually breaches the predetermined level to exit. The trader rather than cutting the position tries to check the chart one more time to see if he can somehow salvage the trade.
Price is now lower than where he wished to exit, so the next thought for the trader is to place a sell order at the buy price. Bounce toh banta hai, Right?
Most of the time though, the stock continues to move against the position he holds and by the time one realizes, it’s close to the end of the day. If the trader is Short and doesn’t hold the stock, he is forced to cut the losses which would generally be much higher than what he had evigased when he first took the trade. If he is long and has funds, the intra-day position becomes a positional trade with the hope that some day the stock will come back to profit when it could be sold.
The optimal way to deal with such situations is to have a broker who will allow you to place a intra-day trade only if accompanied by a stop. A small nudge of that nature can save much misery to a trader.
The most famous nudge of course comes from the Story of Ulysses and the Sirens of the Sea.
So, what does this have to do with my friend and his equity allocation going to ELSS funds instead of normal funds.
Theoretically other than the lock-in and the tax advantage, ELSS funds are similar to any other fund. In fact, some funds like Quantum Tax Saving Fund has the exact portfolio of its bigger cousin – Quantum Long Term Value Fund.
Yesterday I conducted a poll to check how long did investors hold Mutual Funds before exiting the same.
What is interesting is the small percentage of people who voted to hold funds for less than 3 years. Here is what AMFI data as of September end has to say in that regard
Data Source: Amfi, Age Wise and Folio Data.
Among both Retail and HNI category, nearly 50% of funds are aged 2 years or lower. One reason could be that a lot of new investors have entered the market and hence haven’t yet completed 2 years of holding.
To get a better understanding if that would be the case, lets take a look at the same data for September 2013. The choice of this month is because Markets and Mutual Fund inflow took off like no other time 2014 onwards.
Notice something peculiar?
Retail Investors had a much higher percentage of fund aged 2 years and above. It would be interesting if we could get data on how many investors holding for 2 years are new to the world of Investing in Mutual Funds and how many had just switched schemes or funds. But that data is not feasible to get, at least at the retail level.
While Nifty is close to it’s all time high, the same cannot be said for funds which focussed on Mid Cap or Small Cap stocks. Even this shall pass, but the temptation is very high for investors and their advisors to shift from funds which have lost value to funds which are focussed on the current favorites – Large Cap Quality for instance. It’s not surprising that from US to India, there has been huge evidence that shows how Investors underperform the very funds they choose to invest into.
My friend seeks to avoid this since markets move in cycles and what is the current favorite rarely remains the favorite for the future as well. By locking in ELSS funds he is also able to give a 3 year time frame for his investments before taking a call on whether he should consider staying with the fund or switch to alternative investments.
In addition, the biggest advantage of ELSS funds are that they aren’t locked to a certain market capitalization. They are more like Multi Cap funds with ability to take advantage of opportunities wherever they lie. That is one less thing to worry about, Right?
We all have our weakness that inhibits our chances of success in the complex world. One way to avoid what is called in Tennis as unforced errors. Warren Buffett in fact has said that such unforced errors of his have cost his investors billions of dollars in lost earnings.
A book that I think compliments Nudge is Atomic Habits by James Clear. Check that out too.
1 Response
[…] Investing in ELSS funds to save tax may not be required going forward for those who don’t wish to take advantage of the exemptions offered. While the tax advantage may go away, the bigger advantage of investing in a ELSS fund is that thanks to the lock-in, scope of one panicking and exiting the fund at the wrong juncture is minimized. I recently wrote a post around that though process – ELSS as a Nudge for Long Term Investing […]