Even though NPS is a product designed exclusively for retirement planning, what attracts most people to NPS is Rs 50,000 extra tax benefit it offers via deduction.
As per the current tax rules (2019-20), there is an additional Rs 50,000 tax deduction available under Section 80CCD (1B) for NPS contributions made in NPS (Tier 1). This benefit is only available to NPS subscribers and most importantly, is available in addition to the Rs 1.5 lac deduction available under Section 80C.
And this extra Rs 50,000 tax deduction for National Pension Scheme NPS is what catches most people’s interest. And such people keep looking for easy-to-use NPS calculators.
But before we find out the details of NPS pension calculations, let me remind here that ideally, investment decisions should be governed by real financial goals and not tax-saving alone (read why?). But most people ignore this important advice and get attracted / give undue importance to things like tax-saving. But let’s not get into that discussion today.
To summarize the tax angle of NPS, investments of up to Rs 50,000 in NPS Tier I account in a financial year qualify for additional tax deduction under Section 80CCD (1B) of the Income Tax Act. This is in addition to the Rs 1.5 lac deduction available via Section 80C.
Now as mentioned earlier, this extra 50,000 NPS tax benefits attracts many.
And I regularly get queries from people, which are broadly like:
“I already utilize my Section 80C limit of Rs 1.5 lac using EPF, PPF vs ELSS, Home Loan EMI Principal repayments, etc. But I want to save more tax. So can I also use NPS for extra tax savings? And if I do, what would be my final retirement corpus and pension if I put just the additional Rs 50,000 every year in NPS?”
Though suitability of NPS for retirement planning is something worth debating, let’s just limit the scope of this article to answer the question below:
What would be the final corpus and pension Rs 50,000 is invested every financial year in NPS Tier 1 account till the age of 60?
Before we run the numbers and kind of simulate the NPS Pension Calculator, we need to understand the latest NPS withdrawal rules (2019):
Minimum 40% of the NPS maturity proceeds (corpus) must be used to purchase an annuity plan. This 40% isn’t taxed. But, the income (or pension) generated from the annuity will be taxed at the then tax slab rate of the retiree.
The remaining 60% is exempt from tax and can be withdrawn as lumpsum.
If they want, then NPS retirees can use more than 40% (up to 100%) of the NPS corpus to purchase the annuity. In that case, the lumpsum available will decrease accordingly. For example – one may choose to purchase the annuity plan using 65% of the NPS corpus on retirement (instead of the required minimum of 40%). He will then only get remaining 35% as a one-time lumpsum tax-free payout.
So according to NPS rules, basically, there is no tax at the time of withdrawal at retirement as i) 40% goes towards annuity purchase tax-free and ii) remaining 60% is paid out immediately as a tax-free amount. The only time any tax has to be paid is on the income being generated from the annuity in later years.
That was about NPS income tax benefits, NPS tax saving and NPS tax exemption. Now let’s come back to the question at hand:
What would be the final corpus and pension Rs 50,000 is invested every financial year in NPS Tier 1 account till the age of 60?
Before we do NPS calculations for 2019, let’s make a few assumptions:
NPS Starting Age – 25 / 30 / 35 / 40
Retirement Age – 60
Investment Tenure – 35 / 30 / 25 / 20 years (as starting age is different but retirement fixed at 60)
Annual NPS investment – Rs 50,000 only
Does investment amount increase every year – No
Expected Returns – 10% (assuming a balanced mix of equity and debt)
Part of corpus used for Annuity purchase on retirement – 40%
Monthly Pension from Annuity – Rs 29-30,000 per month (before taxes)
Start at 30 and Retire at 60 (30 years tenure)
Total Contribution – Rs 15.0 lac
Total NPS Corpus – Rs 90.5 lac
40% used for Annuity Purchase – Rs 36.2 lac
60% Lumpsum Tax Free Payout – Rs 54.3 lac
Monthly Pension from Annuity – Rs 18,000 per month (before taxes)
Start at 35 and Retire at 60 (25 years tenure)
Total Contribution – Rs 12.5 lac
Total NPS Corpus – Rs 54.1 lac
40% used for Annuity Purchase – Rs 21.6 lac
60% Lumpsum Tax Free Payout – 5 lac
Monthly Pension from Annuity – Rs 10-11,000 per month (before taxes)
Start at 40 and Retire at 60 (20 years tenure)
Total Contribution – Rs 10.0 lac
Total NPS Corpus – Rs 31.5 lac
40% used for Annuity Purchase – Rs 12.6 lac
60% Lumpsum Tax Free Payout – Rs 18.9 lac
Monthly Pension from Annuity – Rs 6300 per month (before taxes)
Note – These numbers are indicative, based on an assumed constant average rate of return of 10% and annuity rate of 6% (which may not actually remain constant). The actual returns, final NPS pension, final lump sum amount one gets from NPS may be higher or lower. Also, you never know whether the 80CCD deductions will remain until your retirement or not.
And it’s pretty obvious that to make the most of the NPS (like in many other long term investment product too), the subscriber should ideally start investing as early as possible. And if one increases the annual (or monthly) contribution towards NPS every year (in line with the increase in income), then that would make the final NPS Retirement Corpus even bigger.
So now you have your answers to questions like what would be final NPS retirement corpus and monthly pension (income) in retirement years.
By the way, many people do compare NPS with PPF. But PPF is a pure debt product which too can be used to achieve goals like PPF crorepati if nothing else. But jokes apart, NPS is a hybrid equity-debt product and PPF is pure debt. So ideally, they shouldn’t be compared. Read more about PPF here and if you want, try your hands at this PPF calculator as well.
All said and done, National Pension System or NPS is designed to save for the post-retirement years, by making contributions during the working years. But is it the best-suited product for retirement saving or not? The answer isn’t that easy.
It may be suitable for some people and it may not be suitable for many others.
Many people’s retirement plans are best served via simple SIP in Equity Funds, regular EPF contributions and occasional Debt Funds (for rebalancing, etc.). And if the money being saved monthly towards retirement is high, then Rs 50,000 NPS tax rebate doesn’t seem that attractive for them.
Like a true retirement product, NPS is very illiquid and it’s difficult to take out money before you turn 60 (i.e., retirement age). So for those planning early retirement, it might not be the best option. More so because if you quit NPS before turning 60, then the NPS Rule’s original condition of using 40% corpus for annuity purchase changes to 80 percent! That is, you would compulsorily need to purchase an annuity plan using 80% of your NPS savings. And only the remaining 20% will be paid as a one-time payout. That’s kind of unfair to early retirees!
So no doubt the 80CCD deduction gives you additional tax benefits for investing Rs 50,000 in NPS National Pension Scheme. But NPS tax benefit and tax-saving are one thing and product suitability is another. And whether NPS is actually suitable for you as a retirement savings product or not – is another matter altogether.
Recently, my wife showed me an interesting tweet (link):
Overrated: How fast you are able to reach financial independence.
Underrated: How enjoyable is your journey on way to financial independence.
I was like wow! This makes sense.
She was quick to remind me then that she had said something very similar a few years back! J And interestingly, I had even written about this exact idea in a post titled F.I.R.E. = Financial Independence and Retiring Early. So here I reproduce a part of it for context:
…I was trying to talk to her [my wife] about the rationale of early retirement and she said something that hit me like a bullet.
She told me that in order to achieve my destination quickly, I should not screw up the journey.
[in years leading up to that discussion with my wife], I was increasingly becoming addicted to the idea of investing more and more to accelerate my financial independence (or early retirement). This meant that I was quite reluctant in spending money even on things that were worth spending on.
And this was wrong on my part. Goal achievement (atleast this one) should not be at the cost of killing the joy of several-years long journey.
You can continue to lead a ultra frugal life and hoard tons of money when you are 45 or 50 or whatever. But, will you be able to use that money in ways that would have been possible when you were young?
No.
I have never made a secret of my desire to become financially independent as early as possible. But working towards this goal requires sacrifices. You need to defer gratification, curtail unnecessary expenditures, save much more than what normal people do. It’s a tradeoff that is to be accepted in this journey.
For me, financial independence still remains my biggest financial goal.
But will I be stressed and strangulate myself (and not spend money more freely) if I don’t achieve it as planned – i.e. financial independence by 40?
Hell No!
I already made course correction a few years back when I realized this.
So maybe, I am not saving as much as I actually can if I push myself more. But that is fine with me even if it means that my so-called ‘early’ retirement will be delayed by a few years. 🙂
Coming back to the original tweet:
Overrated: How fast you are able to reach financial independence.
Underrated: How enjoyable is your journey on the way to financial independence.
Ofcourse fast is quantifiable and enjoyable isn’t. But hopefully, now you understand why it’s worth comparing the two in the context of financial independence.
And let me add a bit of numbers to this discussion to drive home the point better…
Don’t worry. It’s not complex maths. Just simple stuff – understand the basic maths behind financial independence first:
As per a popular FIRE thumb rule, you need a corpus equal to atleast 25* times annual expenses for financial independence.
* – Many say that having 30X or 40X may be a more appropriate and safer approach. But let’s stick to 25X for simplicity and discussion sake.
Now if the X (which is the annual expense) is small, that means you can save more and in turn reach 25X faster.
How?
Read on (and this is important)…
Suppose your annual income is Rs 12 lac. And your annual expenses (i.e. X) are Rs 8 lac. So using 25X thumb rule, you need 25 times Rs 8 lac – which is Rs 2 Cr as the Financial Independence Corpus. And to achieve it, you have Rs 4 lac every year (Rs 12 lac income minus Rs 8 lac expenses) to save for the goal.
Note – Ignore inflation, etc. for simplicity.
Now let’s make the X a little smallER.
Your annual income is still Rs 12 lac. But now, your annual expenses (i.e. X) is smallER at Rs 6 lac (reduced from Rs 8 lac earlier). Now using the 25X rule, you would need 25 times Rs 6 lac – which is Rs 1.5 Cr as the Financial Independence Corpus. More importantly, you now have a higher Rs 6 lac every year (Rs 12 lac income minus Rs 6 lac expenses) to save for the goal.
So the target has reduced from Rs 2 Cr to Rs 1.5 Cr. And you also have a higher amount of Rs 6 lac per year (instead of Rs 4 lac) to save for the goal. Obviously, the time required to reach the target would reduce too. And this is How to really Accelerate your Financial Independence.
Lowering expenses has the double benefit of reducing the target and increasing your savings capability to achieve that reduced target.
Think of it like this – If your expenses are low, you need a smaller corpus to support it for years to come. And a smaller corpus means that you will require a lesser number of years to achieve it. But if your expenses are high, then not only will your required corpus would be high, but it will also require more time and probably a higher saving rate.
In other words, higher is your savings rate (meaning lower the expenses), sooner can you potentially achieve FI (or FIRE = Financial Independence Retire Early).
Recently, a friend told me that he had ‘finally’ managed to save Rs 1 crore (not including his real estate investments). And he was quite happy about this achievement as the first crore is a big milestone no doubt when it comes to us Indians.
In the course of our conversation, he casually asked a simple question –
Can I Retire with Rs 1 Crore in India today?
To me, it seemed that the bug of early retirement had bitten him too as he is just 33 – though the disease seemed in its infancy. 😉
But given my prior knowledge of his not-so-frugal lifestyle (despite good income), I knew that it won’t be possible. And I told him so. His reaction was that of a person who had been slapped hard. 😉
But this got me thinking…
What if someone had a comparatively more frugal lifestyle than my friend or was much older and nearing retirement (around 60), then would Rs 1 crore be enough to retire in India today?
Ofcourse it would depend on various factors. But what do you think?
Suppose you too had Rs 1 Crore today. Can you retire comfortably depending on where you are in life?
I can already hear the ‘No’ssss…
So let me disappoint you all a bit.
For most readers of Stable Investor, a corpus of Rs 1 crore will not be enough to retire.
Sorry. That’s the reality.
But let’s anyway see why Rs 1 crore may not be enough for most people’s retirement now. And if you too are thinking why I have chosen the figure of Rs 1 crore, then its more about the psychological attachment we Indians have with such large figures (more so with the word ‘Crore’) when it comes to saving for long term goals like retirement.
Retirement Corpus Returns – 8% – portfolio mainly has debt (giving 6-8%) and some equity (giving 10-12%)
Average Inflation – 6%
Life Expectancy – 85 years
In this scenario, the money runs out by 79th year. Here is how:
So you see that Rs 1 crore is insufficient to provide for all expenses in 25 years of retirement (from age 60 to 85) in the given scenario.
Your options? Either reduce the expenses or don’t live long enough. Only the former is under your control as the latter (forcing yourself to not live long enough) is suicide and punishable under Indian laws.
But jokes apart, there are few important things to think about this above scenario:
First, in spite of regular expense being Rs 40,000 monthly or Rs 4.8 lac annually, an additional buffer of Rs 1.2 lac has been kept. You may feel that why am I overestimating the expenses, maybe unnecessarily? But this kind of overestimation or let’s say, having such buffers in retirement calculations is advisable. And that is because the retirement portfolio is open to some big risks:
Sequence of Returns Risk – In the calculations, it is assumed that corpus will generate 8% average returns each and every year. But in reality, when the corpus is deployed in a mix of equity and debt, some years you might get higher returns from equity while in other years, you might see lower (or even negative) returns. Even debt returns move around a bit. So the overall portfolio returns will fluctuate accordingly. And if the initial sequence of returns in first few years is bad (or less than our assumption of 8%), then the corpus will get depleted much faster due to withdrawals for regular expenses and much lower returns replenishing the corpus (or losses depleting the corpus).
Higher inflation Risk – We have assumed a reasonable (but more than the currently prevalent) 6% inflation in retirement years. But it is possible that the actual inflation in atleast few years may be unexpectedly higher. Who knows? This will naturally result in faster depletion of the retirement corpus if the retiree cannot reduce his expenses appropriately.
Longevity Risk – We have assumed that life expectancy (from corpus dependence perspective) is 85. It’s entirely possible that you or spouse or luckily both (!) live much longer. If that’s the case, then you don’t want to run out of money at that age. Isn’t it?
Unexpected and Uninsured Big Medical Expense – Its possible that an unexpectedly large medical expense (which is not fully covered by health insurance) might force you to dip into the retirement corpus (assuming no help from family/friends etc.). If that happens, then that too can compromise the corpus’s potential to last for full 25+ years.
Adverse Future Taxation – You never know when the tax regime may change for the worse. They might unexpectedly introduce some new taxes or clauses which will result in lower in-hand post-retirement income or need to withdraw more from the corpus as the in-hand after-tax figures will be less.
So it is for these reasons (potential risks) that you need to have some buffers while calculating the retirement scenarios.
Another aspect is, and you will agree with me here, that “8% return every year” is a hypothetical scenario.
A more realistic scenario would be the retiree parking the corpus of Rs 1 crore in a conservative portfolio with 25% equity and 75% debt. With equity returns fluctuating every year between very high (let’s say +49%) to very low (let’s say -27%) and debt returns ranging from 6% to 9%.
I have simulated a return sequence of 25-26 years which eventually delivers 8% CAGR (our original return assumption used earlier). Have a look below:
Spend some time on the table above. A portfolio of 25% equity and 75% debt sees fluctuating returns every year. So the actual portfolio return every year varies but the 25+ year CAGR works out to be just what we wanted – a neat 8%.
And this is the problem with the concept of CAGR – an average CAGR of 8% does not mean 8% every year. I have written about this phenomenon in detail here and here. A lot of people fail to understand it and make mistakes in their expectations. And that can be disastrous.
Let’s now use the above sequence of realistic fluctuating returns on the Rs 1 Crore retirement portfolio from which, withdrawals for retirement expenses are taking place.
Let’s see how long it survives now:
Coincidently, this also survives till the age of 79-80.
You might ask – nothing has changed from the earlier example. But remember that this is just one of the possible sequence of returns. There can be millions of other sequence of year-wise returns.
As I mentioned in the risks of getting a string (sequence) of poor returns in the initial years, it can suddenly destroy the retirement corpus and lead to a retirement failure. More so if the equity allocation is unnecessarily high to begin with.
Equity Returns in the first 4 years: (-)12% returns each in first 4 years
Equity Returns in later years: same as used in the above example
Debt Returns: same as in the above example
Expenses: same as in the above example
Have a look at the simulation below. The corpus struggles due to a bad sequence of returns in the first 4 years (and high allocation to that struggling asset, i.e. equity) and gets exhausted in just the 72-73rd year itself:
This is exactly what the Sequence of Return Risk is.
A poor sequence of returns in initial years can deplete the corpus very fast if exposure to the asset giving poor returns is high.
And you never know what would be the sequence of returns in the initial years of your retirement. It may be good. It may be bad. You cannot choose the sequence. So that risk is always there. There are ways to manage this risk to some extent.
So now you see the difficulty in answering optimistically to questions like Will Rs 1 crore last full life? Or, How long your Rs 1 crore will last?
If you too were looking for the perfect answer to Can I Retire With Rs 1 Crore in India today? then it really depends on a ton of factors. There are no simple thumb rules here.
Retirement planning isn’t exactly rocket science. But its fairly tricky and a little difficult.
And not because it involves number crunching, but because of the uncertainties associated with all the factors that impact it. It is really not just about punching numbers in an online retirement planner or excel retirement calculator that many people feel it is. It has been rightly called as the Nastiest Problem in Finance. Do read the linked article and you too will be stressed about the idea of retirement calculations themselves! My apologies for painting a bleak picture but I try to share realities on Stable Investor.
And please if you do get hold of any sample Rs 1 crore retirement plan, then remember that it is not necessary that it will be applicable in your case too. Copy-pasting doesn’t work in personal finance.
For all middle class and young people, even though Rs 1 crore sounds like a large number, it won’t be enough because of not-so-low inflation and lack of social security in India. It might still work in certain cases where there are other sources of income post-retirement (like rental, your or/and spouse’s pension, etc.). But if the dependency is only on the retirement corpus, then it can be safely said that:
Don’t retire with Rs 1 crore in India!
Make sure you give retirement planning (or early retirement planning) the serious thought it deserves.
Ideally, the very first step should be to separate the goal of retirement planning from all other short/medium-term goals like a house purchase, children’s higher education and marriage, travelling, etc. Keeping the goal of retirement separate from other goal ensures that you can give it the undivided attention it deserves and more importantly, you don’t end up dipping into the retirement savings like many people do without realizing its consequences.
Is Rs 1 crore good enough for your retirement is not the right question. You should rather ask How much money is enough to retire in India?
Ideally, a methodical and mathematical approach should be followed for planning your retirement savings. If you can do it correctly (and you should first know what can go wrong and where – do not miss reading this to understand), then it is fine. Else, better to take good advice from an advisor for proper retirement planning. Or you can even consider full financial planning that among other things, will also take care of your retirement goal.
Whatever path you chose to put in place your retirement plan, make sure you do not delay it, don’t get your assumptions wrong and more importantly, begin soon.
If you invest in NPS (National Pension System), then I am sure you would be interested in knowing the following:
How much money you can accumulate in NPS by retirement?
How much NPS retirement corpus will you have?
How much tax-free withdrawal is allowed from NPS at retirement?
How much will be your retirement NPS pension?
For answering such questions, I have created a small free excel NPS calculator. This NPS calculator acts as a tool that you can use to estimate the NPS retirement corpus and monthly pension when you retire at 60.
You can call it NPS maturity Value calculator or NPS family pension calculator or National Pension Scheme calculator or NPS monthly pension calculator too.
It is a simple, easy-to-use and can be used as a NPS Pension Calculator as well. It’s a basic version and hence, illustrates only the following:
NPS Corpus accumulated by retirement (age 60)
Tax-Free Lumpsum withdrawal available
Pension amount or annuity payable on retirement (after the purchase of annuity using minimum 40% of the NPS corpus accumulated)
Under latest NPS rules 2019-20, you are not allowed to withdraw the entire amount at maturity and need to purchase annuities worth at least40% of your accumulated NPS corpus at retirement. The remaining 60% of the corpus can be withdrawn tax-free. This annuity purchased is the source of pension income after retirement. Hence, once you are able to estimate your final retirement NPS corpus, you can then easily estimate post-retirement monthly pension using prevalent annuity rates.
Note – The new pension scheme calculation formula is already embedded in the NPS calculator excel sheet but please remember that the calculations and figures shown by the NPS calculator are indicative only. Is this NPS Tier 1 and Tier 2 calculator? You can say that. Or just assume that Tier 1 (which is locked-in till retirement) is the one being used mostly for actual retirement planning.
This National Pension Scheme Calculator gives a reasonable idea of how much retirement savings can you do using NPS. A lot of people have been looking to download NPS excel calculator and hence, will find this useful as a pension calculator.
As you already know, the government gives extra tax benefits via additional deduction of up to Rs 50,000 per year to NPS investors under Section 80CCD (1B). This benefit is in addition to the Rs 1.5 lac limit of Section 80C.
By investing Rs 50,000 per year in NPS (or less than Rs 5000 per month in NPS), you can create a large enough corpus by the time you retire (assuming you start saving early). And since NPS can give market-based returns if you choose correct asset allocation between Equity, Corporate Bonds and Government Securities, it is a fairly decent product to have in your retirement savings portfolio.
With this NPS calculator, you will know how much Pension and tax-free lump sum amount you will get at retirement at 60.
As for the NPS Calculator Inputs, you need to provide the following:
Your current age (assumed you start investing at this age)
Retirement Age – fixed here at 60
Monthly NPS contribution
Annual increase in monthly contributions
Asset Allocation of NPS portfolio (to be provided for Equity, Government Bonds and Corporate Bonds)*
Starting Corpus if any (if you put lumpsum at the start of NPS)
Lumpsum withdrawal at retirement (can be between 0% to 60%)
Amount used for Annuity Purchase (can be between 40% and 100%)
NPS Annuity Rate % during the post-retirement period
* With regards to the choice of asset allocation in NPS, the NPS has 2 broad Investment options:
Active – Under NPS Active option, you decide how much to invest (exact percentages) in each asset (and their schemes). As of now, there are 4 asset classes:
Asset class E – Equity and related instruments
Asset class G – Government Bonds and related instruments
Asset class C – Corporate debt and related instruments
Asset Class A – Alternative Investment Funds
The total allocation across E, G, C and A asset classes must be equal to 100%. And the maximum permitted Equity Investment is 75% of the total asset allocation till the age of 50. Post that, the upper cap reduces by about 2.5% every year to 50% at the age of 60.
Auto – Under NPS Auto option, fund allocation takes place automatically. This option is best for those subscribers who do not have the required knowledge to manage their NPS investments. In this option, the investments are made in life-cycle funds and depending on the risk appetite of NPS Subscriber, there are three options available within ‘Auto Choice’:
Aggressive – LC75 – Aggressive Life Cycle Fund: This Life cycle fund provides a cap of 75% of the total assets for Equity investment. The exposure in Equity Investments starts with 75% till 35 years of age and gradually reduces and goes down to 15% by the age of 55 and beyond.
Moderate – LC50 – Moderate Life Cycle Fund: This Life cycle fund provides a cap of 50% of the total assets for Equity investment. The exposure in Equity Investments starts with 50% till 35 years of age and gradually reduces and goes down to 10% by the age of 55 and beyond.
Conservative – LC25 – Conservative Life Cycle Fund: This Life cycle fund provides a cap of 25% of the total assets for Equity investment. The exposure in Equity Investments starts with 25% till 35 years of age and gradually reduces and goes down to 5% by the age of 55 and beyond.
That was about the NPS portfolio allocation between various assets and schemes.
Now here is what the National Pension Scheme Calculator (or NPS calculator) calculates and shows as output once the inputs are provided:
The total amount invested (contributed) during the accumulation phase
The total corpus accumulated
Amount available as one-time tax-free withdrawal
Amount used for Annuity Purchase
Monthly Pension Amount during retirement years
Like any other investment product, NPS also benefits from compounding. So more the invested money, the more the accumulated amount and the larger would be the eventual benefit of the accumulated pension wealth. To find out the Best NPS Funds Managers (2019 2020) and to check returns generated by NPS schemes, please check out this link – NPS Scheme Fund Manager Returns.
Here again, is the link to download the calculator:
NPS is one of the few products that have been made specifically for retirement savings. Other good ones being PPF (Public Provident Fund Interest Rates and How to become a PPF Crorepati and Free PPF Calculator), EPF and doing regular long term SIP in Equity Funds. The investment in NPS also offers tax benefit under Section 80C (within Rs 1.5 lac per year) and extra benefit under Section 80CCD (1B) upto Rs 50,000 per year. This makes NPS as an attractive retirement solution for many people who are looking for NPS tier 1 and tier 2 tax benefits. As for NPS Tier 1 and Tier 2 which is better? Since Tier 1 has a lock-in practically till retirement, its better option for retirement planning. Tier 2 is best for non-retirement related savings – which can be for other financial goals as well.
But it must be noted that whether it should be the only retirement product that you invest in or not is debatable. There is a case for investing separately in equity funds for retirement as well.
Hopefully, this excel based NPS Pension calculator will help you understand the retirement savings product NPS better and also act as a decision-making tool to make informed investment decisions about how much to invest in NPS for retirement savings.
Note – This is a guest post by Ajay. He has previously written on this topic here. Since a few years had passed, he was kind enough to share his views again (with a useful real-life example). Ajay has also authored other interest posts here like How He created a corpus of Rs 3.7 Crore in just 10 years. So over to Ajay for this post…
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A few years back, I had written on a controversial topic – Investing in Mutual Funds Vs Real Estate in India. I wanted to do a follow-up post on the topic as with each passing year, a new set of people begin asking the same questions:
Are mutual funds better than real estate for investing in India?
Can investing in real estate be better than investing in equity funds?
Mutual Funds Vs Real Estate – which is better
And similar versions asking the same things…
So let me try and address this again…
I once again reiterate that there will be many reasons for investing (or let’s say putting money) in real estate – such as peer pressure, family pressure, social status etc. and I am not debating the same. This question of whether you should invest in Real Estate (for investment) or Mutual Funds, can only be answered by you and you alone.
And therefore, this article should ideally be read in that spirit.
The intention of this post is to present facts based on the actual data, from both real estate and mutual funds from an investor’s perspective and ofcourse, my opinion on the same. 🙂
Also, as stated in the earlier post:
A home is a place to live and it should not be linked to one’s investment strategy. There should not be any second thought about buying your 1st property for self-occupancy whether with or without tax benefits.
I am aware and acknowledge the fact that being Equity and Equity Funds oriented investor, my views will tend to be biased towards Equity investments than Real Estate investments.
The experience and the actual investment returns of Real Estate investors vary from location to location. And therefore, many of you may not agree with the conclusion or findings of this post. Nevertheless, through this article, I have analyzed the actual data from the Real estate and mutual fund investments in India.
So let’s go ahead…
Real Estate Investment
In August-2010, a friend of mine decided to buy a 1200 Square feet (Sq.ft). Flat in the outskirts of Bangalore (@ Rs 2290 per Sq.ft.) through a housing loan. The details are as follows:
Cost of Flat (including Car parking, Utilities, Legal costs, Deposits etc.): Rs 31,39,500
VAT, Registration & Stamp paper: Rs 3,02,566
Total Cost of Flat (all Inclusive): Rs 34,42,066
To fund this purchase, he used:
His own money (Rs 12,42,066) and
Took a home loan for Rs 22,00,000 from a bank.
The loan EMI was Rs.21,343.
As like many of you committed individuals, he paid all the loan EMI on or before the due dates, and also increased the EMI amounts as his salary increased during the loan tenure. He also made part payments many times to accelerate the loan closure and to settle the loan as early as possible. He also put this house on monthly rental as he had to live in another city for professional reasons.
Now let’s look at the numbers below (if you are interested in the actual loan cashflow data):
Now the loan ended recently (in May-2019).
So I sat with my friend and re-calculated the actual cost of his flat:
Total Cost (Flat in Hand) – Rs 34.4 lac
Downpayment – Rs 12.42 lac
Loan – Rs 22.00 lac
Total EMI Paid – Rs 25.73 lac
Total Initial Downpayment & Prepayments – Rs 18.67 lac
Actual Cost of Flat (excl. rent)- Rs 44.40 lac
Rent Received – Rs 11.36 lac
Net Amount Paid for Flat – Rs 33.04 lac
These are real numbers. Real actual numbers.
Let’s move further.
With the loan completed in almost 9 years time, and with the general assumption of property appreciation, we expected the property to fetch at least double the investment (value) of net amount paid for the flat.
So we expected Rs 66 lac from the sale of the property.
However, we did not find a single buyer even at Rs 55 lac!!
From the local brokers and available market information, we got to know that the property could be sold immediately for Rs 40 to 42 lac and if we were lucky, it can be sold for a stretched value of Rs 45-48 lac (let’s say max Rs 50 lac). Also, there will be capital gains tax on the profit amount.
While it is concerning that there was no value appreciation despite the area is connected and having all the basic amenities in the near vicinity, I decided to take this as a case study to see an alternative scenario – where investments had been made in Mutual Funds. I wanted to know what would have been the outcome.
Mutual Fund Investment
I chose 3 funds to feed the investment data in MF (same amount invested as EMI, downpayment and prepayment on the same date as the loan payments were made).
The choice of funds were as follows:
1 decent performing fund (Franklin India Equity),
1 market performer (UTI Nifty 50 Index Fund), and
1 worst performing fund (LIC Multi-Cap Fund)
Since the direct plans weren’t available in 2010, regular plan (i.e. ones with higher fee and lower returns) were chosen for data crunching. So here are the details below (or you can skip and go straight to the summary just after the table):
Summary of the above investment table is as follows:
Conclusion:
From the table above, it is clearly evident that if instead of buying the flat, the investment was rather made in the worst performing mutual fund, it would still have given returns of Rs 55.5 lac against Rs 40-48 lac current market value of the flat.
Investment in the index fund would have fetched a much better Rs 67.94 lac. And if you luckily had invested in a very good fund, then it would have given you about Rs 78+ lac.
Not bad. Right?
I know what many of you might be thinking…
While we can debate the time of entry in mutual funds, time of entry or locality or high cost paid for the property etc., I still find merit in investing in Mutual Funds instead of Real Estate flats as an investment. And I very well know that irrespective of the above data favouring MFs, many will still argue in favour of the real estate. I leave the decision to you.
An important point that shouldn’t be missed in this Mutual fund vs real estate debate is the importance of selecting a good fund (or avoiding bad ones) for investment. And if we stretch this topic a little, it opens up another separate debate on the Active versus Passive Funds which I guess is best left for another post.
Note: In the calculation of Real Estate, the cost for Home Insurance, Home Maintenance, etc. was not included. Also, the Rs 2 Lac tax savings during this tenure was not considered as there will be a capital gain tax on property investment too. Equity investment until March-2018 were are tax-free and therefore, the tax implication would be negligible in case of equity investment in the above case study’s tenure.
Concluding Thoughts
As stated in the previous post on the debate of real estate vs mutual funds, I once again have the same concluding thoughts.
And this is a repetition of the earlier statement. One should not give any second thought about buying the 1st house/property for self-occupancy, whether it is with or without tax benefits.
However, based on the comparative analysis done above, one should think twice (or even ten times…) before buying a home for investment purpose. One should carefully weigh all the available data (Or as much reliable information you have) and then take a wise call.
Just because your friend or family members are investing in real estate does not mean that you should also do it.
Diversification aspect should also be looked at. But you should not avoid evaluating your own financial goals. This is extremely critical. And don’t just evaluate and feel helpless about it. Find out how you can plan to achieve them and then decide whether you actually need (or want) to ‘invest’ in real estate or not. Different people will get different answers.
Without doubt, a physical asset (like a house) will always give huge mental comfort and satisfaction over other financial assets like mutual funds. But it is also true that it may not always be the best available investment option. In fact, investing in house funded through a loan, is a huge long-term liability – which in many cases, chokes the person’s ability to save and invest for other goals in right instruments.
In my opinion (and it is mine so you can choose to ignore it), after the purchase of the 1st property for self-use, if there is any surplus cash left to invest, you should invest it as per your asset allocation (which includes debt, equity, gold & real estate). If the asset allocation permits you to invest in real estate, you may very well do it. But if it doesn’t, then you should refrain from investing in it just because it’s what everyone else around you is doing.
As stated at the beginning of this article too, this is one hell of a controversial debate.
And there is no one straight-forward or logical answer to it. There are no thumb rules either. You and you alone can answer the question of Real Estate Vs Mutual Funds.
In this article (and in the earlier one), all I have tried is to attempt to clear the myth that “Real estate investing is the only best Investment Option” available for everyone. As you might have noticed (if you have spent some time reading the tables above), that all calculations have been done by estimating the returns net of expenses. We just cannot ignore expenses like those many who just tell you the number of times their property has appreciated in value. It’s not correct.
Hope you found this analysis interesting and useful.
Yesterday, I was talking to a young relative of mine about how Sensex had touched 39,000 for the first time and how it had created immense wealth for investors in past years.
But despite being young, this guy was somehow not too convinced about equity’s potential for wealth creation.
So I thought I will try to influence him with some simple data. And once I did that, his mind started working in ways that I liked. Mission accomplished. 😉
I thought of sharing that dataset here.
It’s fairly simple to understand:
Imagine you can invest Rs 1 lac every year. So over a period of 20 years, you would be investing a total Rs 20 lac.
Now, what would be the value of these investments over the years?
I took the Nifty50 returns data of the last 20 years (since 1997-98) and showed the below table to my relative:
After investing Rs 20 lac over 20 years, the value of investments was about Rs 90 lac. This is when the investments were made in January every year.
A large figure of Rs 90 lac excited this relative of mine. But he had a valid question after that.
Since markets fluctuate, what would have happened if instead of investing in January, he invested in some other months?
So I showed him the data for months of April, July and October. Have a look.
By investing Rs 1 lac in April every year in Nifty50 for the past 20 years, the value of investments would have become Rs 87 lac. Not bad.
By investing Rs 1 lac in July every year in Nifty50 for the past 20 years, the value of investments would have become Rs 92 lac. Not bad at all.
By investing Rs 1 lac in October every year in Nifty50 for the past 20 years, the value of investments would have become Rs 94 lac. Not bad again.
Ofcourse the figures differ depending on the months we invest in. But the final figure still is good enough to show how wealth is created over the years when investing in equity.
And just to drive home the point, I also compared this with Rs 1 lac investment in PPF for the last 20 years. Here is what I found:
By investing Rs 1 lac every year in PPF for the past 20 years, the value of investments would have become approx. Rs 52 lac. Not bad but much lower than what was possible via equity.
Please don’t think that I am trying to portray PPF in a bad light. I personally like PPF and feel thatPPF is a great debt product.
So if you understand the whole premise of asset allocation and also understand the need to have debt in the investment portfolio, then PPF is a great option. (Try thisPPF excel calculator). But ignoring equities just because it can be volatile in short term is not wise.
Equity will go up as well as down. It is in its nature. It’s not a bank FD. But if you stick to it for long, the returns delivered are much higher than debt products.
And that is what I wanted to convince my relative about.
He seems to be convinced now. Whether he takes any action on this new found conviction is another matter.
I also shared with him the idea of investing on a monthly basis viaSIP in equity funds if he (like most people) doesn’t have lumpsum amounts to invest. He got inspired by the severalSIP success storiesthat one can easily find.
So if you too feel that someone needs a little push to consider equity for long term investments, then you can use the examples above to convince them.
Is it better to invest lump sum or
monthly SIP in mutual funds?
A lot of people ask me such questions – whether SIP (Systematic Investment Plan) is better than lump sum investing in mutual funds in India? Or whether lumpsum investing is better than mutual fund SIP?
Why I don’t
like these questions (are SIPs better
than lumpsum investments?) is because as usual, there is no one right
answer here.
There are
shades of grey and it isn’t exactly an ideal comparison.
People want
to simply compare SIP vs one time investment in mutual funds or just want to find
out which are top mutual funds for SIP in 2019 or best mutual funds for lump
sum investment in 2019 and what not. But there are no perfect answers or ready
lists that predict anything.
And let’s
look at it from a common-sense perspective.
Before even
getting into lump sum vs monthly investment debate, the decision to invest in
lump sum or SIP depends on whether one actually has enough investible surplus
that can be called as lumpsum!
Right?
If one doesn’t
even have this ‘lump sum’ then this question of SIP or lump sum in itself is
meaningless. It’s only when this ‘lumpsum’ is actually available that the
question holds any relevance.
And once
the lump sum is there, the next question should be whether investing in one go
is better or whether it’s wiser to spread that lump sum over a short period of
time, as there can be several best ways to invest a large sum of money in
mutual funds. Just because the lump sum is available doesn’t mean that the
money should be invested in one go. There are can various other tactics to
deploy it more efficiently.
But nevertheless, there are those who prefer SIP (and have SIP success stories to tell) and there are those who prefer lump sum investing.
And to be
honest, both methods work in different set of circumstances.
Let’s try
to do this comparison as objectively as possible.
SIP vs Lumpsum in Rising
(Bull) Markets
In a rising
market, your lumpsum investments in mutual funds will produce higher returns
than SIPs. That’s because the cost of purchase in a lumpsum investment in a
rising market would always be lower than the average cost of purchase in SIP, which
is spread out across higher and higher purchase prices for each SIP
installment.
Let’s take a
very simple hypothetical example to show this.
Suppose one investor invests Rs 5000 per month in a rising market for 12 months. While the other invests Rs 60,000 as lumpsum at the start itself. Both invest in mutual funds a total of Rs 60,000. Here is how it pans out over the next 12 months:
As can be
seen above, the average cost (average NAV) for the SIP investor in a rising
market is higher. And hence, the future hypothetical profit when sold later,
will be lower for the SIP than that of the lumpsum investor.
Now let’s
look at a falling market scenario.
SIP vs Lumpsum in Falling
(Bear) Markets
In a
falling market, the SIP investing would result in comparatively lower losses
than that in lump sum. And that is because the cost of purchase in a lumpsum
investment in a falling market would always be higher than the average cost of
purchase in SIP.
Here is how
it looks:
As can be
seen, the average cost for the SIP investor in a falling market is lower. And
hence, the future hypothetical profit when sold later, will be higher for the SIP
investor than it is for the lumpsum investor.
So
basically what is happening is that if the market grows continuously, then lump
sum investing gives higher returns whereas if it falls continuously, then SIP
investing is better (lesser losses than that of lumpsum investing in such
scenario).
Ofcourse in practice, the markets neither go up nor go down continuously for very long. So the actual reality may be somewhere in between the two above discussed scenarios of sip vs one time investment in mutual funds.
In some cases, SIP may give better
returns than lumpsum investing. While in other cases, lumpsum will give better
return than SIP investing. And in many other cases, the result of both will be
pretty similar.
It all depends on the future sequence of returns that the investor gets. If you want to know how much wealth your SIP will create, try using this SIP maturity value calculator.
But let me
circle back to the original point I made – whether
you invest lumpsum or otherwise first depends on whether you have a lumpsum or
not.
Right?
And if you
have, then obviously it would be wiser to just invest lumpsum when the market
is low. Remember Buy-low-sell-high?
But problem
is that you will never know when the market is really low. You can be wrong
about your assessment and enter at precisely wrong times.
And that
said, what about our ‘real’ nature and how we behave?
Most
investors are unable to use common sense when their portfolios are down.
But very
few people have the guts to go out and invest more money (assuming they have
more). Fear plays a major role in investing and unfortunately, you can neither back-test
emotions nor fear. And you will only know in hindsight whether is it best time
to invest in mutual funds or not.
Imagine
investing lumpsum in December 2007 when markets were peaking and then
helplessly witnessing the fall down till March 2009. On the other hand, if you
invested a lump sum in March 2009 instead (at the bottom), you would have been called
the next Warren Buffett!
Both are
extreme examples but show how lumpsum investors potentially expose their portfolios
to the vagaries of the market. There is always the risk of being completely
wrong and mistiming. And that is the problem. To be fair, one can also get the
timing right and if willing to spend sleepless nights in the short term, can go
on to make much higher returns than usual in medium to longer term. But that’s
how the dynamics of lumpsum investments are.
Due to their
structural nature, SIPs reduce this risk of being completely wrong as the
investments are spread out. So asking whether is this the right time to invest
in SIP is immaterial as SIP spreads out your investments. Ofcourse your returns
will depend on how the markets play out during the spreading-out period. But
that is how it is.
For small
investors, SIP is also suitable from their cashflow perspective. They rarely have
access to large lumpsum that is ‘surplus enough’ to be available for long term
investing.
By putting away small amounts periodically, there isn’t a large pressure on their resources and no doubt is convenient. This is the reason that for small investors, SIP is their best bet even if not a perfect strategy.
Remember
that SIP is a tool to optimize returns and match your investment needs to your
cashflows. It is not a magician’s magic to generate superior returns to lumpsum
investing. Read that again.
One can use the SIP investing to slowly build up a large corpus over the years without straining the finances in present or worrying about timing the markets perfectly. You can try to use this sort of yearly SIP calculator to understand how much money you need to save for various financial goals.
I know that
many of you are more focused on saving taxes.
And one popular way to save taxes these days is to go for best tax saving ELSS funds vs PPF. But there also, people tend to get confused whether to go for SIP or lump sum for ELSS when investing in top ELSS mutual funds. Nevertheless, the logic that we have been discussing till now remains the same irrespective of whether it’s an ELSS fund or a normal mutual fund.
Now let’s take
a step further…
What if you
have a lump sum that can be invested. Should you go ahead and invest it in one
go or do something else?
Should you Invest Lump Sum
In One Shot Or Systematically & Gradually?
A smart
investor would recognize the market bottoming out and invest in one go. But we
all aren’t smart. So if you aren’t sure if it’s the right time to invest in one
go, you can even deploy your lump sum gradually.
There is no
one single answer to which is the best
method to invest a lump sum in mutual funds?
So
depending on the market conditions, investor’s investment horizon and risk (and
volatility) appetite, a deployment strategy may have to be worked out. This
strategy may either aim for lowering risk or maximizing returns or a
combination of the two.
One way is
to put lump sum investment in debt mutual fund and gradually deploy the money using
STP or Systematic Transfer Plan into an equity fund.
Different
investor needs would demand different lumpsum deployment strategies.
Being a small investor, it can be daunting to find out which are the best SIP plans that can be considered for long term investments. Or for that matter to find out which are the best mutual funds for lumpsum investment or the best tax saving mutual funds in India or whether to do ELSS SIP or lump sum.
If you don’t know how to find good funds or need help with planning your investments, do get in touch with a capable advisor to help you. It is worth it.
Finally…
I am sorry
if you did not find the one specific answer to your question of SIP
or Lumpsum which is better for investing.
A direct
comparison between SIP and lumpsum investing is neither fair nor accurately
possible. And unless we know everything about the investor in question, one
cannot say confidently which is better suited for whom.
You may feel that there is a secret to find the best time to invest in mutual funds India but there is no secret. Different investors need to follow different investment strategies for SIP and lump sum investing. And ofcourse an awareness of market conditions and how market history plays out is absolutely necessary. You can’t be blind to that.
All said
and done, SIP is a comparatively safer option but we cannot deny that at times,
lump sum investing will provide better returns if done correctly.
Which is better SIP or lump sum investment in top best mutual funds in 2019?
This may
sound repetitive but the truth is the superiority of SIP over lump sum or of
lumpsum investments over SIP varies under different conditions.
Is SIP better
than one time investment? Or lump sum is better than SIP? Systematic Investment
Plan vs Lump sum Investment? It is all a matter of probability and what is the sequence
of returns that comes in future and how investor behaves during the period in
consideration. That’s all there is to it.
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. JPeople 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.
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.
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)
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:
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).
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:
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.
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.
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.
