Yesterday, someone sent me an infographic that tracked the performance of PPF vis-à-vis ELSS over a 15-year period.
With a monthly investment of Rs 10,000, PPF would have returned Rs 35.49 lakh while ELSS would have returned Rs 49.16 lakh. I am clueless as to which ELSS was taken, so am going to assume that it was the category average that was referred to.
The conclusion it drew: Over the long term, ELSS is a more suitable tax-saving investment under Section 80C.
Let me tell you why I found the above conclusion to be terribly flawed.
PPF: How to get the best out of it
The PPF is NOT an alternative to ELSS, or vice versa.
Investors tend to make the grievous error of assuming that all investments that fall under Section 80C are similar and can be blindly compared – ELSS, PPF, NSC, 5-year bank deposits. This reveals all that is wrong with most individuals’ tax-planning strategy.
PPF and ELSS are not similar asset classes and must not be pitched against each other without taking the individual’s profile and overall portfolio into account.
The Public Provident Fund (PPF), is a sovereign-backed assured return product. Being a fixed-return investment backed by the central government, it stands for the highest safety. I dealt with it in detail in PPF: How to get the best out of it.
On the other hand, the Equity Linked Savings Scheme (ELSS) is a mutual fund that invests in equity. This is a market-linked investment; such funds invest at least 65% of their assets in stocks of domestic companies.
Tax Saving: 6 common mistakes
So how must you decide?
Let me start by narrating some of the experiences of my colleagues at Morningstar.
Kaustubh Belapurkar who heads fund research, told me that he has never felt the need to have a PPF account as all his tax-saving is done via ELSS.
Conversely, senior analyst Himanshu Srivastava gets his entire Section 80C utilized without any investment in ELSS or PPF (to understand this, read Tax Saving: Earn the right to invest). However, he likes the longevity and security that the product offers and so ensures that he has a PPF account running.
Senior investment analyst Chintan Mehta has had an interesting change of heart. His portfolio is heavily tilted towards stocks and equity mutual funds. He never viewed PPF as a retirement savings tool because with almost three decades to retirement, he could well afford to park his money in equity. Hence, he naturally exhausted his Section 80C with ELSS.
In the recent past, Chintan came to the realization that in an emergency, one tends to liquidate their stocks and mutual funds. To have a retirement saving option that one does not touch is what got him to open a PPF account. The long-term lock-in which so many despise, is what got him attracted to it.
Can you see the trend of thought? In none of the above instances is it an ad-hoc decision. The choice between the two is made based on their investment goals and overall portfolio.
In my case, I max the entire amount (Rs 1,50,000) in PPF every single year. I do this because I do have an equity heavy portfolio and continue with monthly investments in equity funds. I also have a separate emergency fund and investments in short-term debt funds should I need cash. Hence am completely open to a long-term fixed-return investment; it fits in nicely in my portfolio.
So when faced with ELSS and PPF, you need to go back to your portfolio. The different asset classes in a portfolio must complement each other. To draw an analogy, the 64 black and white squares on a chessboard complement each other and give structure to the layout. Each occupies a different position and serves a purpose. A chess board must have both black and white squares.
Depending on a host of factors, you will have to arrive at your own equity:debt allocation. Within that, you will have to fine tune. For instance, if the equity portion of your portfolio is heavily skewed towards large-cap stocks and funds, then you need a multi-cap or mid-cap fund to supplement it. It cannot be supplemented by a debt holding.
I want to drum this home: PPF (debt product) cannot be an alternative or supplement to ELSS (diversified equity mutual fund) as both are intrinsically different.
Tax Saving: Earn the right to invest
Keep in mind
- ELSS is better suited to manage the risk of loss of capital and the erosion of purchasing power due to inflation. PPF provides complete safety and an assured return. But the decision on whether to opt for PPF or ELSS must be taken after viewing your entire asset allocation. If you are heavily tilted towards equity, PPF can be considered. If you have a debt-heavy portfolio, ELSS should fall within your purview.
- Your investment plan must be proactive, not reactive. By this I mean that tax saving should be in sync with the overall strategy and not a hurried exercise at the end of the financial year, where you pick up PPF or ELSS simply because you don’t know what else to do.
- Tax optimisation of individual financial products has to be the last step in the overall financial plan and not the basis for selection or comparative analysis.
