Public Provident Funds (PPF) and Equity Linked Savings Schemes (ELSS) are two of the most popular avenues when it comes to tax savings under Section 80 C. And so, despite being quite different, they are often compared to each other.
Public Provident Funds (PPF) and Equity Linked Savings Schemes (ELSS) are two of the most popular avenues when it comes to tax savings under Section 80 C. And so, despite being quite different, they are often compared to each other. (See table 1)
However, before we discuss these two categories of investment avenues, it is important to go back to Investing 101. All funds, in their essence act like intermediaries between borrowers and lenders of capital. When you invest in any fund, you are the lender. Hence, the most natural way to think about your investments is to understand the nature of the borrower. For the purpose of our present discussion all we need to know is that, irrespective of the fund we invest our savings in, the money will ultimately go towards investments that can either give us a fixed return every year or variable returns based on business performance. In other words, debt instruments or equity linked instruments.
ELSS is a pure equity-based investment while PPF invests in government bonds. As a result ELSS funds give you much higher returns but, like any equity oriented instrument, can be volatile. PPF, on the other hand, is extremely safe, gives you assured but much lower returns.
For a lot of people, PPF has been the go to tax-saving investment given its risk averse, fixed interest nature. But now, it’s time to reassess this blind ritual that so many of us follow as a last minute tax savings investment. The question that arises is whether the safety element of a PPF is worth the low returns and extremely long lock in period. Even the ELSS fund with the lowest returns in the category has given more than 13% returns in a five-year period and average returns over a three & five-year period have been more than 17%. (See table 3)
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On the other hand, interest rates in India have been trending downwards for some time now and returns of small savings schemes like the PPF have also come off from their highs. (See table 2) In fact, it was in February this year that the Finance Minister announced that small savings rates will be reset on a quarterly basis instead of annually. For the ongoing quarter (October to December 2016), PPF interest rate is at 8%, and is only expected to fall further going ahead.
Another key thing to consider is the liquidity aspect of your investment. While the lock-in period of ELSS is 3 years, PPF locks in your investment for 15 years. You can make a partial withdrawal after the investment completes 5 years, but only if you prove that the money is needed for a medical emergency or for higher education.
So, what should you do?
1. First and foremost, do not leave your tax planning for the last minute and make ad hoc investments.
2. Think about your financial goals, your risk profile and when you plan on using this investment corpus and accordingly choose your tax-saving instrument in line with your other investments.
3. It also helps if you allocate this investment towards a particular financial goal.
4. It’s very important to remember that the volatility of equity investments significantly reduces, the longer you hold on to them. So if your time horizon is more than 3 years, then ELSS funds is a better choice. Ideally, remain invested in ELSS funds for at least 5 years.
5. If you’re extremely risk averse, then you could look at splitting your corpus between ELSS & PPF. The PPF investment will ensure your capital remains protected and the ELSS investment will provide an additional boost in your overall returns.
Your tax planning has to be in sync with your overall investment portfolio. For example, if you’ve already got three or four mutual funds in your portfolio, adding a fifth one might not make sense unless it’s for a specific goal or if you choose to stop one of the other funds. Similarly, if your debt allocation is on the lower side and needs to be topped up, then even if your risk appetite is high, opting for a PPF might make more sense.
When it comes to tax planning, there is no quick fix or one size that fits all. Your choice of investment must be in line with your overall equity & debt allocation.
Table 1: ELSS VS PPF: WHAT’S THE DIFFERENCE?
|Underlying instrument||Equity||Govt. bonds|
|Lock-in period||3 years||15 years (Partial withdrawal possible 5th year onwards for medical or educational purposes.)|
|Investment Limit||No Limit||Rs 1.5 lakhs annually|
|Eligible for tax deduction u/s 80 C||Rs.1.5 lakhs||Rs.1.5 lakhs|
|Interest rate||Market-linked||Reset quarterly. 8% for Oct-Dec 2016 quarter.|
Table 2: PPF RETURNS SNAPSHOT
2000 – 2001
2001 – 2002
2002 – 2003
2003 – 2011
2011 – 2012
2012 – 2013
2013 – 2016
Apr 16′ – June 16′
July 16′ – Sept 16′
Oct 16′ – Dec 16′
Table 3: TOP PERFORMING ELSS FUNDS
3 Year Returns
5 Year Returns
Reliance Tax Saver
Axis Long Term Equity Fund
DSP BlackRock Tax Saver
Birla Sun Life Tax Relief 96
Principal Tax Savings Fund
Birla Sun Life Tax Plan
ICICI Pru Long Term Equity Fund
The author, Avni Raja is Associate Editor, BankBazaar.com