WHY TO SETTLE FOR LESS…!

To avail of the deduction under Section 80C, should I invest in PPF or ELSS?

  • Before we move on, let us look at both investment options.

The Public Provident Fund, or PPF, and an equity linked savings plan, or ELSS, are eligible for a deduction under Section 80C of the Income Tax Act, which has been upped to Rs 1.50 lakh now.

The amount you invest in PPF is eligible for a deduction, the interest earned is tax-free and the entire amount on maturity (principal + interest accumulated) is also tax free.

In other words, it is exempt from tax all the way — what is referred to as EEE (Exempt Exempt Exempt tax).

When you invest in an ELSS, you get the deduction under the relevant section. Since the money has to stay invested for at least three years; there is no long-term capital gains tax that has to be paid.

As far as the tax benefit goes, both score high. The differences are stark when looking at the risk barometer.

 

Since the return in PPF is guaranteed and is backed by the government, there is no risk associated with it. The icing on the cake is that investments in a PPF account cannot be attached under any court order with respect to any debt or liability of the account holder.

But while PPF is identified as a risk-free investment, no investment is 100 per cent free of every possible risk. Any investor who parks too much money in fixed-income assets can face other types of risk such as inflation risk and shortfall risk.

A high rate of inflation would erode the value of your savings. Shortfall risk is the risk that an investment’s actual return will be less than the expected return, or more accurately, the return needed to meet one’s investment goals.

Then there is the 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.

The return in PPF has declined over the years. From 12 per cent at the turn of the century, it dropped down to 11 per cent, then 9.5 per cent, 9 per cent and finally below 8 per cent is where PPF returns languished for many years. From FY12 to FY17 the rate has come down from 8.6 per cent to 7.9 per cent as the table shows below:

PPF Interest Rate History (Last 30 years)

  • PPF Interest Rate 1986 to Jan-2000 – 0%
  • PPF Interest Rate Jan-2000 to Feb-2001 – 0%
  • PPF Interest Rate Mar-2001 to Feb-2002 – 5%
  • PPF Interest Rate Mar-2002 to Feb-2003 – 0%
  • PPF Interest Rate Mar-2003 to Nov-2011 – 0%
  • PPF Interest Rate Dec-2011 to Mar-2012 – 6%
  • PPF Interest Rate 2012-13 – 8%
  • PPF Interest Rate 2013-14 – 7%
  • PPF Interest Rate 2014-15 – 7%
  • PPF Interest Rate 2015-16 – 7%
  • PPF Interest Rate 2016-17 (1st April 2016- 30th September 2016) – 1%
  • PPF Interest Rate 2016-17 (1st October 2016 – 31st March 2017) – 0%
  • PPF Interest Rate 2017-18 (Currently – 1st April 2017 onwards) – 9%

All in all, the PPF has not done an excellent job in consistently beating inflation over the last few years.

If we look at the average returns of the ELSS category over the past 10 years, as on July 31,, 2017 they stood at around 15% per cent annualised. Do note, this is just the average return and there will be funds that have delivered a more superior returns. The average returns of the ELSS mutual funds for the period of last 15 years hover around 17-18%.

Investors can fall short of their financial goals for many reasons — key among them is under-saving. But if you’re saving for a long-term goal, holding too much in investments with no short-term volatility — but proportionately low returns — can contribute to shortfall in your long term financial goal. That happens with PPF.

To achieve investment success (which we define as reaching your financial goal), investors must have a portfolio that blends various asset classes.

If your portfolio does have a very heavy equity exposure otherwise, then by all means exhaust the Section 80C limit with an investment in PPF. However, do take into account your principal repayment of the home loan, child’s tuition fees, contributions to Employee Provident Fund, or EPF, and premiums paid for life insurance and only then the balance should be invested in PPF.

On the other hand, if your equity exposure is much less than desired, then you could look at ELSS. But don’t be in a tearing hurry to sell your fund units on completion of three years. Exit from the fund when the market is rallying so you walk away with a profit. If this means hanging on for a few more years, do so.

So in conclusion, there is no simple right or wrong with regards to PPF and ELSS. Both are completely different products. PPF must find a place in every investor’s portfolio, but so must equity. Good tax management can go a long way toward enhancing your return. Therefore, history shows us that ELSS mutual fund schemes have beaten PPF by a wide margin by delivering much more returns over  the periods of 5,10,15 and 20 years (almost double than the present PPF return of 7.9%).

red and green apples
  • RETURN COMPARISON OF ELSS AND PPF :

ELSS and PPF work on different investment objective. ELSS invests in shares to maximize the return whereas PPF investment is in government bonds  which hardly give returns more than the bank FDs.

The equities always give the best returns over long term. The historical data have proven it. The interest rate of PPF is fixed every year. At present it is based on the 10-year  government  bond yield. The interest  rate on PPF is almost similar to 5-10 year bank FD. In the following table we can see the wild fluctuations of the ELSS returns while PPF gave a constant return. But, on average the ELSS mutual fund schemes have delivered double annualized returns than PPF. The CAGR of last 13 years is mere 8.0% while that of ELSS is  18%.


If you had
invested Rs 1 lakh in PPF and ELSS at the same time 13 years ago, your money in PPF would have been Rs 2.75 lakh while the same would have been Rs 8.62 lakh in ELSS, a whopping difference of almost Rs 6 lakh.

  • LOCK-IN PERIOD :

Every investment which gives you tax benefits always come with some limitation of redemption. The lock-in period in PPF is 15 years while the same in ELSS is only 3 years. A PPF account is for a period of minimum 15 years. You get the maturity amount after the completion of 15 years. Of course you can take loan against PPF.  You can withdraw a partial amount from the start of the 7th financial year after opening your PPF account subject to certain rules.

Therefore, ELSS is more flexible and more productive. The thumb rule is that equity investments always deliver best returns over a long time horizon.

Why to Settle for Less???

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