Jignesh Shah – Capital Advisors | Jun 28, 2016, 09.36 AM | Source: Moneycontrol.com
How the PPF and ELSS score on various parameters. Here is how you can take an informed decision.
Recently one of my clients asked me – with 2.5% loss in Sensex over last one year, why not avoid tax saving mutual funds and instead go for investment in public provident fund? He has a point when we look at negative returns by stocks. But just one bad year, does not make tax saving funds a bad investment choice. There is much more one should ponder over before taking a decision.
Public provident fund (PPF) and tax saving funds (ELSS) are different products – former is fixed income instrument and the latter is an investment in stocks. ELSS can be a volatile journey and may not suit risk averse investors. However, it comes with the combination of two big advantages – lock in of just three years and a possibility of returns in excess of inflation.
PPF offers tax free assured returns in long term. But the returns may not remain attractive. The interest rate may drop below 8% given the falling interest rate regime we are into.
While some investors may want to include both these options in their portfolio, it makes sense to delve deeper into each one of them before you invest.
PPF – It is a scheme issued by the Government of India under the PPF Act of 1968. It is a fixed income security scheme that enables one to invest a minimum amount of Rs.500 and a maximum of Rs.150,000 per annum. PPF account matures after 15 years. So, the lock-in period for PPF investment reduces every year. Compared to this, with ELSS, every investment is subject to a fresh lock-in of three years.
Returns are not fixed. Interest rate for the year is notified by Ministry of Finance, Government of India. Interest rate for FY2016 is 8.7% p.a. and 8.1% for qtr ended Jun 2016, which is excellent for a debt product.
Individuals who are residents of India can ONLY open an account under the scheme. Only one PPF account can be maintained by an Individual, except an account that is opened on behalf of a minor. Thus, PPF account can also be opened by either parent under the name of a minor. However, each person is eligible for only one account under his/her name. Mother and father both cannot open Public Provident Fund (PPF) accounts on behalf of the same minor. Thus, in case a couple has two children, they can maximum open four accounts i.e. two in their own accounts and two in the name of their children under guardianship of either of the parent. Also, non-resident Indians (NRIs) are NOT eligible to open an account. However a resident who becomes an NRI during the tenure prescribed under Public Provident Fund Scheme, may continue to subscribe to the fund until its maturity on a non-repatriation basis. However, such an account will not be eligible for extension of five years at the time of maturity, if at the time of maturity, an account holder is an NRI. Since 13th May, 2005, Hindu Undivided Family can NOT open an account under the scheme. However, accounts opened prior to that date may continue subscription to their account till maturity. They also can not extend the account any further, after this date.
One can have guaranteed and tax free returns by investing in a PPF account. Currently, deposits under PPF earn interest of 8.10% per annum. PPF investments are tax deductible, along with the fact, that the returns are completely, tax free. The lock in period of the PPF scheme is as long as fifteen years and can be extended in block of five years after maturity. Partial withdrawals can be made on the commencement of the seventh year.
Since, the return in PPF is guaranteed and is backed by the government, there is low risk associated with repayment. However, any investor who parks too much money in fixed-income assets can face other types of risk such as inflation risk. A high rate of inflation would erode the value of your savings. There is an issue of liquidity too – should the investor need the money for some emergency it would be difficult since the PPF has a lock-in period of 15 years
Other Features –
1. Premature withdrawal of funds – PPFs give a hard time when it comes to withdrawing investments before the maturity of 15 years is done. Partial withdrawals are permitted from the seventh year.
2. Loans – Having lock-in periods of 15 years and being stable financial instruments, from the third year, PPFs can easily be used as collaterals for availing loans for vehicles, housing and other secured loans.
3. Investment Security – Provided by the Government of India, PPFs offer rates that rarely change in a major way and are one of the safest possible investments one can make in India.
After initial maturity of 15 years, you can extend your PPF account in block of 5 years.
PPF falls in Exempt-Exempt-Exempt (EEE) category. Interest earned and the maturity amount is exempt from income tax.
Now, let us look at ELSS –
Equity Linked Savings Scheme (ELSS), is an instrument of savings and investment managed by many mutual funds. It is a diversified equity mutual fund. A minimum investment of Rs.500 is required and it has no cap on the maximum investment. It has a mandatory lock-in period of 3 years, after which all the investment and the returns can be withdrawn. These investments offer tax free returns as long term capital gains on equity funds are tax free. dividend on equity based mutual fund is exempt from dividend distribution tax as well. Being equity market linked investments, these have a higher risk, but also present a better case of gaining more returns than any other savings scheme that relies on fixed income instruments.
Other Features –
1. Premature withdrawal of funds – Premature withdrawal of funds from ELSS investments is not allowed – not until the lock-in period of 3 years is over.
2. Loans – Equity Linked Savings Scheme investments are market dependent instruments and can only be used as collaterals for availing loans for vehicles, housing and other secured loans after the lock-in periods are over. Better rates can be availed on loans, if investments are pledged with banks that offer the particular ELSS schemes
3. Comparison of risk and returns –
Should you invest in PPF or ELSS?
Your investment choice should be guided by your investment objectives and your risk tolerance level and liquidity requirements. Investors with high risk tolerance should invest in ELSS, while investors with low risk tolerance should invest in PPF. Over a long time frame, wealth creation potential is much higher with ELSS. Young investors should opt for ELSS, since they usually have high risk tolerance and a sufficiently long time horizon to ride out the volatilities associated with equity investments. As you approach retirement, your risk tolerance goes down and PPF is a better investment option in such a situation. Investors with moderate risk tolerance level can invest in both PPF and ELSS in accordance with their optimal asset allocation strategy.
Salaried individuals are mandatorily required to contribute a portion of their salary to employee provident fund (EPF). The EPF interest rate is similar to the PPF interest rate and the maturity amount is tax free. The EPF contribution of the employee as well as PPF and ELSS investments goes towards the section 80C tax savings. If you are not a salaried individual and looking for some safe fixed income saving option, PPF can be considered.
Returns –ELSS is expected to offer better returns than PPF in long term. Currently, average 5 year compounded return for ELSS schemes is 13.31% pa and average 10 year compounded return for ELSS schemes is 12.86% pa. This is far better than PPF rate of return of more than 8%.
Risks – Over longer term, volatility (price risk) reduces significantly, in equity instruments. There is little risk of capital in PPF, as it is backed by Central Government of India.
When investing, investors must also consider shortfall risk. This is the risk that an investment’s actual return will not be sufficient to generate the money needed to meet one’s investment goals. That is why equity is so crucial in an investor’s portfolio because good equity investments over the long term do provide returns which outpace inflation. According to inflation.eu, the average CPI in India over the past 10 years has fluctuated in wide range of 5.7% (2016) to 12.11% (2010).
If investors invested all their money in fixed return investments like PPF, there is a very high probability that they would not save sufficiently for retirement, unless they were earning obscene amounts of money.
Also, the return in PPF has declined over the years. From 12% at the turn of the century, it dropped down to 11%, then 9.5%, 9% and finally 8%+ where is languished for many years. Between FY12 and FY15 the rate hovered between 8.6% and 8.7%. If you take the average inflation by year, the CPI from 2008 to 2013 has fluctuated between 8.32% and 12.11%. All in all, the PPF has not done an excellent job in consistently beating inflation over the last few years. You need some equity to create wealth.
To sum up, if you are willing to take up some risk go with an ELSS, otherwise it is the good old PPF makes a better bet.
Source : http://goo.gl/30NIYP