Benefit from the Default Effect: Make Equity Linked Saving Scheme your stepping stone to long-term investments in Equity
Investors wanting to achieve the basic arithmetic combination of saving taxes and building wealth – both at one go – can consider investing in Equity linked Saving Schemes (ELSS).A lot is already written about the twin virtues of tax benefits and equity investments, but one attractive feature that is rarely talked about is the default ‘lock-in’ feature.
Understanding ‘The Default Effect’:
“To do nothing is within the power of all men”, said Samuel Johnson.
The default effect is the phenomenon where making an option the default among a set of choices increases the likelihood of it being chosen.
Defaults in our daily life have evolved consistently – voice commands have replaced typing, thumb impression has replaced keys and in the near future, driverless cars are likely to replace drivers. From Pre-filled web pages to the size of coffee cups, from ‘Web apps’ with standard settings to public policy, the ‘default’ option has surely proven its utility.
One would wonder – why is ‘default setting’ the most preferred option. Reason: it saves the user from the trouble of decision making.
The key culprit is ‘Effort’. Because choosing something that is not default requires effort. The amount of effort required may be different – and only if the perceived reward of effort is greater than the input, will a user be willing to invest time in making changes.
The Power of good Defaults
Today, Default Effect 1 and Nudge Theory 2 are widely used as effective tools in administering public policy. The US administration uses principles of Nudge for encouraging long term savings in their pension policy. Making enrolments a default option, ensures a higher rate of participation and hence higher retirement savings.
Austria and Sweden presume consent for ‘Organ Donation’ making it a default. People who do not wish to donate their organs have to fill an Opt-out form – thereby increasing ‘effort’ for not pledging their organs. It is no surprise that both these countries have 99% and 86% organ donation rates respectively as opposed to 12% in Germany and 17% in the United Kingdom.
For equity instruments a reasonably long term lock-in may well serve as a useful default.
‘Lock-in’ prevent impulsive mistakes
Volatility in the stock markets affect investor’s minds. These behavioural hindrances to wealth creation can be dealt with if investors keep their emotions in check during market crashes. Investments in tax-saving schemes have lock-in period of three years. This can prevent reactions caused by the fear induced through sharp corrections.
2020 is a good case in point – the sharp correction led to a ~25,000 cr redemption in Equity mutual funds in March’20. Markets saw a V-shaped recovery from the bottom – Nifty 50 bottomed out wiping out 35% from the index and climbed back to scale all-time highs in December’20. The Default choice of 3 yr lock-in would have saved many-a-investor from the need to react.
An equally opposite behaviour of throwing caution to wind is seen during euphoric bull-runs.
As they say, the most difficult thing in investing is ‘doing nothing’.
Two valid critiques of ‘lock-in’ are 1) liquidity and 2) Is 3 years is good enough time horizon.
1)Liquidity: Listed below are the tax saving options that have a higher lock-in period compared to Equity Linked Saving Schemes.
|Investment/Saving Instrument||Mandatory Lock-in Period|
|National Pension Scheme||Till Retirement|
|Unit Linked Insurance Plans||5 Years|
|National Saving Certificate||5 Years|
|Senior Citizen Saving Scheme||5 Years|
|Bank FD s||5 Years|
If liquidity were of paramount importance to investors, then these tax saving options would have got far lesser allocations. We know for a fact that all the above mentioned options, barring NPS, have a far larger corpus compared to some of the best ELSS fund.
2)Is 3 years good enough: The best way to judge this would be to examine 3 year rolling returns for all ELSS funds since the inception of this category (1996).The average 3 year rolling return (calculated on a daily rolling basis) for all ELSS schemes is 14.85%.
Also, there is no need to exit after completing three years. If you stick to your investments in ELSS and keep adding more to it each year, you are likely to make higher returns in the long-term.
In the bestseller ‘Sapiens — A Brief History of Humankind’, Yoval Noah Harari explains how gossip helped us rule the world. Well, I believe, the lock-in benefit in the best ELSS funds, would be one thing worth gossiping about.
Umang Thaker – Head-Products, Motilal Oswal Asset Management Company Limited.
1.When and why defaults influence decisions: a meta-analysis of default effects : JON M. JACHIMOWICZ* Columbia Business School, New York, NY, USA, SHANNON DUNCAN Columbia Business School, New York, NY, USA; ELKE U. WEBER Princeton University, Princeton, NJ, USA and ERIC J . JOHNSON Columbia Business School, New York, NY, USA.
2.Nudge: Improving Decisions About Health, Wealth, and Happiness – Richard H Thaler and Cass R Sunstien.
This article has been issued on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this document is for general purposes only and not a complete disclosure of every material fact. The Stocks mentioned herein is for explaining the concept and shall not be construed as an investment advice to any party. The information / data herein alone is not sufficient and shouldn’t be used for the development or implementation of an investment strategy. It should not be construed as investment advice to any party. All opinions, figures, estimates and data included in this article are as on date. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The statements contained herein may include statements of future expectations and other forward-looking statements that are based on our current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Readers shall be fully responsible/liable for any decision taken on the basis of this article. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
For individual nature of tax implications, investors are requested to consult their tax advisors before investing
Mutual Fund Investments are subject to market risks, read all scheme related documents carefully
Leave a Reply