Category: Personal Finance

Should I invest in PPF or ELSS to save taxes?

This is a common question that I am asked quite often, more so during the tax saving season.

Choosing between the ever so popular Public Provident Fund (PPF) and Equity-linked Saving Schemes (ELSS).

To be fair, comparing one to the other isn’t exactly correct. But I will get to that in a bit.

If you think about it, the main motive behind such PPF vs ELSS questions is fairly obvious – the more tax you pay, the less money remains in your hands. So you will naturally try to find ways to save more taxes. And if these tax saving efforts can help you earn good returns, then nothing like it. Isn’t it?

Unfortunately, people want a clear-cut, crisp, one-word answer to such ELSS vs PPF questions.

But that’s easier said than done. Things aren’t always black and white. There are hundreds of shades of greys in between.

Another question derived from the earlier one is whether doing SIP in ELSS funds is better than investing in PPF every month?

Those who are risk averse obviously feel PPF is a better savings option. While those who have got good returns from ELSS funds in the past (or know that equity is the best asset to create long-term wealth) advocate going for SIP in ELSS funds.

And here is an interesting fact: the number of such PPF vs tax saving ELSS debates rises during the tax saving season. J People are in a mad rush to do some glamorous, last-minute tax savings and portray themselves as financial superheroes!

But last-minute tax saving efforts near the end of the financial year is a recipe for disaster.

Many end up buying shi*** traditional insurance policies to save tax. That’s even worse than being wrong about choosing between ELSS and PPF.

But let’s not digress and instead focus on the main questions at hand:

• Is ELSS mutual fund better tax-saving investment option than PPF (Public Provident Fund)? Or
• Is PPF better tax-saving option than ELSS funds (Equity Linked Saving Schemes)?

No doubt both are very popular.

And when you ask people about the best tax saving investment options, chances are high that you will get either ELSS or PPF as the answer.

But as I said earlier, there is no perfect or one clearly defined right or wrong answer to this debate.

Ofcourse if you pick just one of the several parameters, you are bound to find one clear winner. But that is not the right approach.

But let’s begin the comparison anyway…

Most people prefer to compare returns.

Unfortunately, that is neither wise nor a fair comparison.

PPF as a product is extremely safe and gives assured returns whereas returns from ELSS depend on the performance of the stock markets. So the returns of ELSS can be very high or very low and fluctuate somewhere in between.

Both are completely different products and target different needs of a portfolio. So we shouldn’t even be comparing them!

But people do and will continue to compare.

And one very big reason why people compare them is that both have a good and instant side-effect of providing tax-saving… that too under the same Section 80C of the Income Tax Act. Hence people tend to compare.

I know what you are thinking.

Firstly, we are concerned about tax-saving. Right? That’s common between ELSS and PPF. So nothing much to compare.

Next obvious choice is to compare returns. What else could it have been?

You are right to an extent.

But I am of this view that all investments should be linked to financial goals. Tax saving should not be the prime motive for most investors (Talking of goals, if you still aren’t sure which goals you are or should be targeting, I strongly suggest you use this FREE Excel-based Financial Goal Planner to find out what your real personal financial goals are.)

Your goals and investment horizon play a major role in defining how you invest. If investing for long-term goals, the investment portfolio should ideally have a larger equity component. Whereas when saving for short-term goals, it should be a less volatile and debt-heavy portfolio. The asset allocation differs for different financial goals. That’s how it should be.

I will not delve into the full details of what PPF is or what tax-saving ELSS funds are. I am sure you already know most things about them. But just to recap a bit:

• PPF (or Public Provident Fund) is a government-backed debt product that assures returns that are declared from time to time. How much to invest in PPF to save tax? A maximum of Rs 1.5 lakh can be invested in lump sum or installments in one financial year. The lock-in period is 15 years and the account can be extended in blocks of 5 years multiple times after the original 15-year maturity period is over. Tax benefits for investment in PPF under Section 80C are limited to upto Rs 1.5 lakh.
  
• ELSS (or Equity Linked Savings Scheme) is a diversified mutual fund that invests in stocks and also offers benefits under Section 80C. There is no limit on maximum investment but tax benefit is available only on Rs 1.5 lakh. The lock-in period is 3 years. Returns are neither guaranteed nor assured. They are market linked and (average returns) tend to beat inflation in the long term.

Comparison of Returns – ELSS vs PPF

As I have already said, comparing returns of PPF with ELSS isn’t 100% correct.

Both have very different investment objectives.

PPF is a debt product whose returns are fixed but limited due to its very nature. There is no potential for positive or negative surprises. You get what you are promised by the authorities. ELSS, on the other hand, is an equity product that aims to maximize returns. To achieve this aim, it takes risks which can turn out well at times and not turn out well at other times.

To give you some idea about how returns in ELSS funds and PPF differ every year, I have tabulated the annual returns of some of the popular tax-saving ELSS mutual funds in the table below:

The data has been sourced from Value Research. This is not a perfect comparison but is still good enough to give you a comparative snapshot. You can compare the year-wise returns and average category-return of these ELSS funds with PPF annual interest rates. This table will give you some idea about how the returns vary in reality, so I suggest you spend some time on it.

And the funds above are one of the best ELSS funds that have been in existence for last several years now. But do not think of this as an advice of best-ELSS-funds-to-invest kind of list. The data is just for illustration purposes.

But nevertheless, read the observations below:

• PPF returns have mostly ranged from 8.0% to 8.7% in the recent past. To know more about PPF account interest rate in different banks, check the updated latest PPF interest rates.
• The years with green colored PPF-return grids indicate that the PPF was the better performing when compared with other ELSS funds in that year. Like in 2008, PPF delivered 8% whereas the chosen set of ELSS funds gave average returns of -54% with individual funds delivering anything between -48% to -63%. Similarly in 2011, PPF did better than ELSS schemes.
• The years with red PPF return grids show that ELSS gave higher returns than PPF in those years. For example: in 2017, ELSS returns ranged from 26% to 46%. Obviously PPF couldn’t match that with its 8%.
• The smaller grids (max/min) show the maximum and minimum annual return for different ELSS funds for that given year.

It’s clear from above that depending on the market conditions, the ELSS returns can have wild fluctuations. PPF returns on the other hand are more or less constant due to government’s blessings.

So where PPF returns average around 8%, tax saving ELSS mutual funds have the potential to deliver a much superior return – a 12% to 15% average returns is possible, but not guaranteed. And the top best ELSS funds have given much better returns than these average returns.

So does it mean that you should simply dump PPF and start investing everything in ELSS funds?

Ofcourse not! The average return comparison of ELSS and PPF does seem to show that ELSS offers superior returns in the long run. But basing your investment decisions only on one factor is very risky. Here’s why.

Let’s check another aspect before we get judgmental.

A lot of people don’t invest lumpsum and prefer SIP every month. So for them, it’s better to find out how SIP in ELSS funds Vs monthly PPF investment compares.

Let’s check that out too.

I have simulated Rs 10,000 monthly investment in Franklin India Tax Shield Fund* starting from January 2008 to December 2018. This is to be compared with Rs 10,000 per month savings in PPF for the same period.

*Chosen randomly from several ELSS funds. Don’t consider it as a recommendation.

The value of investment in Franklin’s ELSS fund at the end of 2018 would be about Rs 29-30 lakhs. On the other hand, the value of PPF corpus is 20-21 lakh.

Once again and maybe not surprisingly, it seems ELSS is the way to go.

You can also say that in the above case, the PPF-investor has actually lost out on more than 50% extra returns. (Rs 30 lakh – Rs 20 lakh)

Right?

But even if you see it highly possible that you will get more return on ELSS, you need to understand the short-term risks of investing in ELSS funds and how you react to such risks when you actually face them.

Here is why:

I have compared Rs 10,000 monthly SIP in Franklin Tax Shield vs monthly 10,000 savings in PPF starting from April 2007 (when the bull run was about to peak in coming months).

I chose that starting point because due to high returns from equity in recent past (2004-early-2007), many people would be attracted to stock markets and would be interested in ELSS – as it combined tax savings with much higher returns than PPF.

So here is a 2-year story – starting from April 2007 to March 2009:

In 2 years, the total contribution would have been Rs 2.4 lac in each.

And the value of ELSS investment would be Rs 1.6 lac and that of PPF would have been about Rs 2.6 lac (yellow cells in the bottom row).

Now think…

We know equity will do well in long term. That is what has been told and proven countless times

But how many people would remain convinced and loyal to that idea when their Rs 2.4 lakh investment goes down to Rs 1.6 lakh after 2 years?

They might be cursing themselves for ignoring PPF that would have saved them from such losses.

And this is what I wanted to highlight.

And no PPF vs ELSS calculator or SIP vs PPF calculator will tell you this. All such ELSS SIP investment calculators work on the principle of average returns which will not show the real picture.

Just looking at historical average returns, you might feel that investing 100% of the money in stock markets is the right way. But when markets correct, not many people have the ability to stay invested and accept the temporary losses, even though it is best for them.

Looking at the average long-term returns in isolation can give the wrong picture. Equity investing (directly or via mutual funds) does need a lot of will power to remain invested when markets are down. Not many people have it.

So is it better to invest in ELSS mutual funds SIP than in PPF?

It is true that investors of ELSS mutual funds are rewarded for accepting the short-term volatility. They are paid back handsomely as average return table above suggests. But when you invest in markets, you will face periods of stock market volatility every now and then. Like in 2008, the ELSS category fell by almost 50%. Again in 2011, the category average was about -24%.

Equity is perfectly fine for long-term investors and equity funds have given much better returns than PPF over long-term. But you just cannot ignore debt (like PPF) as the investors have different responses to volatility. Some might exit ELSS after 20-30% losses (which is normal in equities).

Another factor is that you don’t have to ‘choose’ anything in PPF. It’s simple.

But in ELSS funds, you have to choose the fund among many available ones. Is there any guarantee that you will be able to choose the right ELSS fund that will do well in future? Think about it. What if you picked the wrong funds?

That was about the comparison of investment returns of PPF vs ELSS mutual funds.

Let’s see other factors.

Tax Benefits on investments in ELSS Vs PPF

Both ELSS and PPF are quite tax efficient.

Under the Income Tax Act Section 80C, investment in ELSS mutual funds and PPF (Public Provident Fund) give you a full tax deduction upto Rs 1.5 lakh every financial year.

Under Section 80C, you cannot claim deduction of more than Rs 1.5 lac when investing in ELSS or/and PPF and/or other section-80 tax saving options.

Also, you cannot invest more than Rs 1.5 lakh in a PPF account in a year. But this restriction is not there in ELSS schemes. You can invest as much as you want, but the tax benefits available will be limited to Rs 1.5 lakh.

And let me answer two more questions that you might have:

• Is maturity of PPF taxable or not?
• Is maturity of ELSS taxable or not?

The answer is:

• PPF – Maturity amount is still not taxed. Cheers!
• ELSS – Maturity amount is taxed at 10% (for long term capital gains tax on equity)

Lock In Period – PPF vs ELSS

A PPF account has a maturity period (lock-in) of 15 years. ELSS funds on the other hand have a lock in period of only 3 years. But wait. There is more to know than just that…

Assuming you make annual investments in PPF, only your first installment in locked-in for 15 years. The 2nd year installment is locked-in for 14 years. The 3rd year installment is locked-in for 13 years…and so on. Also, the PPF accounts that have completed 15-year lock-in and have been extended have a fresh lock-in of only 5-years.

In ELSS, each SIP installment has its own 3-year lock-in. many people get confused here. Do not think that lock in is valid on full amount that you have invested from the date of first investment in ELSS.

So first SIP in April 2017 will be locked in till April 2020. Second SIP in May 2017 will be locked-in till May 2020. And so on…

But let me remind you that equity is best suited for long-term. Like for periods exceeding 5 years. The money is locked for only 3 years in an ELSS fund. But even if the lock-in gets over after 3 years, you shouldn’t withdraw the funds and remain invested for as long as you don’t need the money.

As investors you need to be very clear that the asset that you are investing in is equity and thus you should be ready to stay invested for at least 5 to 7 years to get good returns.

What if you Invest 100% in PPF or 100% in ELSS?

These type of questions come from people who are unwilling to see the bigger picture and are only narrowly focusing and asking about PPF vs mutual funds which is better?

But neither approaches is advisable.

• Is PPF a good option for investment?
• Is ELSS a good option for investment?

Ofcourse yes.

But theoretically speaking, if you invest Rs 1.5 lakh in PPF every year for 15 years, your total corpus would be around Rs 43 lakh. You can use this Excel PPF Maturity Calculator to try out other scenarios (or find out how to save Rs 1 crore in PPF).

On the other hand, if you put in Rs 12,500 per month (= Rs 1.5 lakh per year) in ELSS funds, then your corpus after 15 years would be between Rs 60-82 lakh depending on assumed returns of 12-15%. Also check out How much to invest every month in ELSS funds for Rs 1 crore in 20 years.

Regular SIP in equity funds (both ELSS and non-ELSS) can create a lot of wealth in long run. Here is a good real-life success story of SIP-based Wealth Creation. To know how much wealth you can possibly create by investing small amounts every month, check out the following links:

• SIP of Rs 5000 per month in mutual funds
• SIP of Rs 10,000 per month in mutual funds
• SIP of Rs 15,000 per month in mutual funds
• SIP of Rs 20,000 per month in mutual funds
• SIP of Rs 25,000 per month in mutual funds
• SIP of Rs 50,000 per month in mutual funds
• More SIP options

Again, you might feel that why to use PPF when you can get more returns with ELSS.

But remember, PPF is a debt product and ELSS is an equity product. All goal-based investment portfolios are best constructed by diversifying across assets.

You should not be 100% in equities or 100% in debt.

It is not sensible either way.

For most people, the best approach is to invest in line with your goal requirements. Using the powerful concept of Goal based Investing, you find out how much you should be investing for each goal.

Let’s assume that the goal you have in mind is retirement planning – which is a nasty problem in itself.

It’s a big goal. And since for most people its decades away, its best served by an equity heavy portfolio.

For someone in 30s, it can be safely said that a portfolio with 70% equity and 30% debt is suitable.

And you also wish to save tax. Right?

So here is how to go about it:

• You are investing for your financial goal of retirement planning.
• After doing some calculations yourself (or taking help from an investment advisor), you have come to know that you need to invest Rs 20,000 every month in 70-30 Equity-Debt ratio.
• That means investing Rs 14,000 in equity and Rs 6000 in debt every month.
• But you are already making an EPF contribution of Rs 4000 every month. That also counts towards the 30% debt bucket.
• EPF takes care of 48,000 under Section 80C tax saving options. Assuming you have a Rs 1 crore term insurance with Rs 12,000 annual premium, the total eligible deduction goes upto Rs 60,000 (48K+12K).
• The remaining Rs 2000 per month (from debt) can be put in PPF. Or if you have the option of VPF, that’s better too. This totals to Rs 84,000.
• And this increases eligible deductions to Rs 84,000 (48K+12K+24K). You need another Rs 66,000 for fully utilizing Section 80C limit.
• You can now do a Rs 5500-6000 SIP in ELSS fund. That will take care of your tax-savings.
• For the remaining Rs 8000-9000 (in equity bucket of Rs 14,000), you can choose other normal equity funds (non-ELSS). Or you can even do full Rs 14,000 SIP in ELSS funds.
• All this is assuming that there aren’t any home loan tax benefits to accommodate.

The above approach is a very simple one.

And if you think like that, then you will easily get answers to questions like ‘how much should I invest in ELSS’ and ‘how much should I invest in PPF’?

But you don’t need to decide between PPF and ELSS because of just returns.

You instead simply need to focus on asset allocation (which is 70-30 in the above example). Therefore, the choice between doing SIP in ELSS funds and investing in PPF must also be seen in the context of overall portfolio asset allocation.

If there is room under the 30% debt bucket after deducting EPF contributions, you use PPF. For equity’s 70% bucket, you can use ELSS to the extent it is needed for tax saving.

And if your Section 80C limit of Rs 1.5 lac is fully utilized using EPF contributions, life insurance premiums and home loan principal repayment, there is no need for ELSS mutual funds investment. You can easily focus on non-tax saving equity funds instead.

But that doesn’t mean that you don’t invest for your goals. Tax-saving is not a financial goal. Just remember that.

The approach that I discussed above is in line with goal-based investment’s philosophy.

One simpler approach can be to take a middle path and do a 50-50 split between PPF and ELSS.

Another can be (for those who are interested in being more tactical about tax-saving) to use market valuations as an indicator to decide where to invest. If valuations are low, invest in ELSS. If valuations are very high, invest in PPF.

I am not suggesting that the tactical approach discussed above is a better way. Just highlighting that there can be multiple approaches. But most people are better off not trying to time the markets. 🙂

But the actual split between ELSS and PPF will depend on factors like your risk profile, existing assets, etc.

Just to reiterate, if you are young, keep a larger portion of your savings directed towards equity when investing for long term goals like retirement.

Both ELSS and PPF are suitable for retirement savings. But equity is better suited as long as you have several years left for the goal.

How to choose good Tax-Saving ELSS Mutual Funds?

Before even you consider ELSS as the choice for tax saving, do not forget that always invest in ELSS with a long-term perspective – something like 5+ years or even more.

Why?

Because ELSS is about equity investing. And equity as an asset class isn’t risk free. There is always a risk of loss of capital. But this risk is higher when you invest for short term. The longer your investment horizon, the lower is the risk of loss.

With that aside, how do we go about picking the best ELSS funds among all ELSS mutual fund schemes out there?

These days, the disclaimers about past performance not being necessarily sustained in the future fall on deaf ears.

So despite mutual fund companies highlighting great short term returns, you should focus on things that matter.

When looking for which ELSS funds to invest in for tax saving, keep the below discussed points in mind.

Depending solely on performance numbers from recent past can be misleading. Do not run after previous year’s best performing tax saving ELSS funds. Look for consistency in returns over several years. Has the fund been in the top quartile of its category for almost all the years? Has the fund protected the fall in poor markets? These are just some of the questions that should come to your mind when picking ELSS or building a proper mutual fund portfolio. You can even consult an investment advisor to find out these answers.

Also, all ELSS funds are not the same in terms of portfolio construction.

All ELSS funds are actively managed and its fund manager’s job to decide what to hold in fund’s portfolio. It can a portfolio with a bias towards large cap, midcaps, all caps or whatever.

What is worth remembering is that one ELSS fund’s investment mandate will not be the same as that of the ELSSs out there.

And there is absolutely no need to pick a new ELSS fund every year for your tax saving.

This often happens when you do last minute tax saving. You are in a hurry and want to find out the best performing ELSS fund on the basis of 1-year return. This is not advisable.

Over the years, investors end up with several ELSS schemes as they invest lump sums every year by picking one from the best performer of previous years. Like picking from Top ELSS Funds of 2018 or Top ELSS Funds of 2019.

But having more than 1 or 2 ELSS funds is useless. In any case, if you have other non-tax saving diversified mutual funds, having more ELSS funds will only lead to an overlap in your portfolio. Building a mutual fund portfolio isn’t tough but still people mess it up.

So don’t wait for January, February or March for planning your tax savings.

Do some homework earlier and find out how much is to be invested in ELSS in the year. And then begin investing in ELSS through SIP (systematic investment plans). This way, you would have time to pick good ELSS funds on the basis of long-term consistent performance. You will also benefit from averaging (and avoid timing the market through last minute lump sum investments).

We began this article with the question of whether to invest in PPF or ELSS to save taxes.

But as you have seen, both are completely different products. Both PPF and ELSS serve their own purposes when you combine goal-based investing with smart tax-saving strategies.

You should not decide randomly between ELSS or PPF. And there is no one-size-fits-all answer as both ELSS and PPF target different needs of the investment portfolio.

The decision should be made after you have a clear view of your financial goals and tax requirement.

But when it comes to combining equity investing with tax saving, there is no doubt that ELSS is good for long term investments. It scores well above several other tax saving products. And investing in ELSS through SIP (or systematic investment plans) over a long time horizon can help you do proper tax planning and financial goal planning.

If you have a well-thought out investment plan for your financial goals, you will not need to ask questions like which is a better investment option ELSS or PPF?

You don’t need to choose between the most suitable tax saver between ELSS vs PPF. That is because you will invest on basis of your goal-specific strategic allocation rather than randomly. And that is what goes a long way in sensible investment management and wealth creation. So taking sides on ELSS vs PPF is fine. But invest smartly and using correct goal-based approach.

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