Article

Which is the better investment option: PPF or mutual funds?

15 Jan 2020

Public provident funds (PPF) have been the default favourite of Indian investors for a long time. The reasons are not far to seek. The returns were higher than bank deposits, the tax breaks were at multiple levels and the PPF account had full government guarantee. Investors really could not ask for more. A lot has changed in the last few years. The rates of return on most small savings have consistently come down while new and innovative forms of mutual funds have tried to fill the gap. It is in this context that an investor needs to make the choice of PPF versus mutual funds.

Mutual funds in India have emerged as a veritable investment avenue with the AUM of mutual funds growing three fold in the last five years. Of course, we cannot really compare equity funds with PPF but the comparison will have to be at two levels. We can compare PPF versus ELSS funds based on the tax breaks under Section 80C of the Income Tax Act. At the same time, we can also compare PPF with debt funds as they are similar in character.

Comparing PPF versus ELSS Mutual Funds

Both the PPF contributions and the ELSS contributions are eligible for Section 80C exemption within the overall limit of Rs.150,000 per annum. Let us look at how they compare on other parameters.

  • Purely in terms of returns, ELSS funds would score over PPF. The PPF gives an annual return of 7.9%; subject to change from time to time. However, the trend has been down. ELSS funds, on the other hand, give annual returns in the range of 12-15% if held for a period of over 5 years.

  • In terms of risk, the PPF surely scores because the PPF is virtually free of default risk as it is guaranteed by the government of India. The ELSS fund is an equity fund and hence it carries all the concomitant risk of equities.

  • How do they compare on lock-in period? ELSS scores on this front. The ELSS has a lock-in period of just 3 years. On the other hand, the PPF has a mandatory lock-in of 15 years and any withdrawal or even loan against PPF is only possible after completion of 7 years.

  • In terms of taxability of returns, the PPF has an edge. The interest paid by the PPF is fully tax free in the hands of the investor and there is no tax on redemption. In case of ELSS, the dividends are tax free in the hands of the investor but are subject to DDT at 11.648% (10% DDT + surcharge + cess). Also, capital gains on ELSS are taxable at 10% flat on any gains above Rs.1 lakh. You can our mutual fund calculator to calculate these costs.

  • Finally, where ELSS funds really score is on wealth creation. PPF hardly creates wealth whereas ELSS, due to its inherent equity component, creates wealth over the long term.  This is one of the key factors that give ELSS an edge over PPF as a tax saving tool.

Comparing PPF versus Debt Funds

Debt funds invest in debt securities issued by the central and state governments as well as by institutions and corporates. How do debt funds compare with PPF as an asset class?

  • On the returns front, it is clearly debt funds that score. While the PPF yields around 7.9%, the debt funds with a mix of G-Secs and private debt yield 9-10% returns. This return gets enhanced in years like 2019 when debt funds yielded over 15% due to the 135 bps cut in interest rates.

  • In terms of risk, PPF is clearly lower risk because it is backed by government guarantee. However, debt funds also tend to be relatively safe unless the fund manager goes heavy on credit risk.

  • Clearly, PPF is a lot more tax efficient compared to debt funds. Apart from the Section 80C benefit, the interest is tax free in the hands of the PPF investor. In case of debt funds, there is no Section 80C benefit available. Dividends on debt funds are subject to 29.12% DDT and both STCG and LTCG are taxable in case of debt funds.

  • Where debt funds really score is on liquidity and flexibility. For example, debt funds can be liquidated at very short notice with minimal price damage. Secondly, debt funds can be structured as SIPs, SWPs and STPs, which makes them a lot more flexible compared to PPF; which is a relatively rigid product.

PPF continues to be popular due to its tax efficiency and low risk. Remember, that the biggest risk today is not taking on adequate risk. That should be the guiding principle when you decide on whether to opt for PPF or mutual funds.

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Which is the better investment option: PPF or mutual funds?

15 Jan 2020

Public provident funds (PPF) have been the default favourite of Indian investors for a long time. The reasons are not far to seek. The returns were higher than bank deposits, the tax breaks were at multiple levels and the PPF account had full government guarantee. Investors really could not ask for more. A lot has changed in the last few years. The rates of return on most small savings have consistently come down while new and innovative forms of mutual funds have tried to fill the gap. It is in this context that an investor needs to make the choice of PPF versus mutual funds.

Mutual funds in India have emerged as a veritable investment avenue with the AUM of mutual funds growing three fold in the last five years. Of course, we cannot really compare equity funds with PPF but the comparison will have to be at two levels. We can compare PPF versus ELSS funds based on the tax breaks under Section 80C of the Income Tax Act. At the same time, we can also compare PPF with debt funds as they are similar in character.

Comparing PPF versus ELSS Mutual Funds

Both the PPF contributions and the ELSS contributions are eligible for Section 80C exemption within the overall limit of Rs.150,000 per annum. Let us look at how they compare on other parameters.

  • Purely in terms of returns, ELSS funds would score over PPF. The PPF gives an annual return of 7.9%; subject to change from time to time. However, the trend has been down. ELSS funds, on the other hand, give annual returns in the range of 12-15% if held for a period of over 5 years.

  • In terms of risk, the PPF surely scores because the PPF is virtually free of default risk as it is guaranteed by the government of India. The ELSS fund is an equity fund and hence it carries all the concomitant risk of equities.

  • How do they compare on lock-in period? ELSS scores on this front. The ELSS has a lock-in period of just 3 years. On the other hand, the PPF has a mandatory lock-in of 15 years and any withdrawal or even loan against PPF is only possible after completion of 7 years.

  • In terms of taxability of returns, the PPF has an edge. The interest paid by the PPF is fully tax free in the hands of the investor and there is no tax on redemption. In case of ELSS, the dividends are tax free in the hands of the investor but are subject to DDT at 11.648% (10% DDT + surcharge + cess). Also, capital gains on ELSS are taxable at 10% flat on any gains above Rs.1 lakh. You can our mutual fund calculator to calculate these costs.

  • Finally, where ELSS funds really score is on wealth creation. PPF hardly creates wealth whereas ELSS, due to its inherent equity component, creates wealth over the long term.  This is one of the key factors that give ELSS an edge over PPF as a tax saving tool.

Comparing PPF versus Debt Funds

Debt funds invest in debt securities issued by the central and state governments as well as by institutions and corporates. How do debt funds compare with PPF as an asset class?

  • On the returns front, it is clearly debt funds that score. While the PPF yields around 7.9%, the debt funds with a mix of G-Secs and private debt yield 9-10% returns. This return gets enhanced in years like 2019 when debt funds yielded over 15% due to the 135 bps cut in interest rates.

  • In terms of risk, PPF is clearly lower risk because it is backed by government guarantee. However, debt funds also tend to be relatively safe unless the fund manager goes heavy on credit risk.

  • Clearly, PPF is a lot more tax efficient compared to debt funds. Apart from the Section 80C benefit, the interest is tax free in the hands of the PPF investor. In case of debt funds, there is no Section 80C benefit available. Dividends on debt funds are subject to 29.12% DDT and both STCG and LTCG are taxable in case of debt funds.

  • Where debt funds really score is on liquidity and flexibility. For example, debt funds can be liquidated at very short notice with minimal price damage. Secondly, debt funds can be structured as SIPs, SWPs and STPs, which makes them a lot more flexible compared to PPF; which is a relatively rigid product.

PPF continues to be popular due to its tax efficiency and low risk. Remember, that the biggest risk today is not taking on adequate risk. That should be the guiding principle when you decide on whether to opt for PPF or mutual funds.