After the 2018 budget imposed a 10% tax on long-term capital gains from equity last month, there was a debate whether ELSS still remains the best investment option to save on taxes. From a tax treatment point of view, Public Provident Fund (PPF) may now appear more attractive given that its income is tax free, while the gains from ELSS funds will become taxable. Let us look at the returns to see if PPF can beat ELSS on a post-tax basis.
To do this comparison, we assumed an investment of Rs. 50,000 made at the beginning of each financial year, starting 1st April, 2012. The investments were made in ELSS funds as well as PPF. So as to not get biased by the fund selection, we selected two funds, Franklin India Taxshield, one of the top rated funds, and HDFC Tax Saver, a bottom-quartile fund.
We then looked at the value of the investments after tax at the end of 5 years. We also looked at the returns generated by these investments. This is how much your investments would have returned:
As you can see, even a mediocre-performing fund convincingly beat PPF as an instrument.
We further varied the start date of the investments, and looked at the value of Rs. 50,000 invested at the beginning of each year for the next 5 years. This removes any bias due to market cycles. We then looked at the post tax returns given by the above three instruments. These are the returns that you would have got.
In the above graph, the yellow line tells you how PPF compared with ELSS funds. The line fails to go above the columns 9 out of the 10 times. Again, the post tax returns of both the funds consistently beat the returns given by PPF.
What about the returns of the investment starting in January 2004? The value of these investments is as of 31st March 2009. This date was pretty close to the time when the markets bottomed out after the crash due to the 2008 subprime crisis. Continuing to invest would have pulled up your returns above PPF in two more years.
Apart from higher returns, ELSS funds also enjoy a shorter lock-in period of 3 years (15 years for PPF) and LTCG exemption up to Rs. 1 Lakh which sweeten the deal further.
The return charts above simply tell you that PPF may be a safe option but not anywhere close to delivering superior returns like ELSS. If you have a time frame of 5 years or above, there is every reason for you to choose ELSS over PPF, even post the tax imposed in the recent budget.
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To begin with, PPF is a long term investment product aimed at building a retirement corpus. One can hold a PPF account till the end of life and earn tax free income at the same rate as a bank FD. At some stage in life, one would have to invest the accumulated corpus in ELSS fund in a fixed income instrument like a bank FD which offers steady monthly/quarterly income. Assuming the income tax rates and tax free nature of PPF remains the same as at present, one would require to accumulate in ELSS or any mutual fund scheme, a corpus at least 50.6125% larger than PPF corpus to earn the same post tax income from a bank FD, as the tax free income from PPF in case of assesees in the highest tax bracket. Comparison between PPF and ELSS should be over 15 years or more, in fact over entire working life of 30 to 35 years and not just over five years.. Over long periods, expected returns from equity markets should be restricted to GDP growth plus inflation i.e. no more than 12%, and that too taxable at 10.4% on redemption, except Rs.1 lakh. While ELSS may still score over PPF by a small margin, the safety of capital and certainty of return, though fluctuating quarterly now, gives a peace of mind that equity investment cannot. In any case, PPF is a debt product while ELSS is an equity product and so incomparable. Prudent investors should invest in both equity and debt and PPF is the best debt investment.
I understand your point of view, but I would like to address some points. First, ELSS can be held for a period of 15 years or more. Equity instruments are in fact ideal for such long-term periods.
Regarding regular income, PPF does not provide regular income either. Corpus built under PPF and ELSS will need to be switched into other products to generate regular income. These include a combination of Senior Citizen Saving Scheme, FDs, debt funds. You can use systematic transfers over 4-5 years to gradually move money from ELSS (or equity funds) into debt funds. There is no need to redeem the entire corpus at once. This will also help claim higher capital gains exemption limits and reduce tax outgo.
Historical comparison over a period of 30-35 years is neither feasible nor advisable. ELSS funds do not have that long a track record. Plus, equity and debt markets have matured over the years. PPF rates in the year 2000 used to be 15% p.a. It’s hardly likely to move to these levels again. Looking at that long a history will give you an incorrect picture. Anyway, take the last 15 completed fiscal years (2002-2017). For Rs 50,000 invested annually in PPF and Franklin India Taxshield, the end-corpus in ELSS works out to about Rs 47 lakh and PPF is Rs 15 lakh. The growth in ELSS is large enough that even post-tax, you would wind up with a much higher corpus. With repeated compounding, even a small difference in rate of return creates a huge difference in the value of the corpus.
You can invest in both PPF and ELSS. The point we’re making is that ELSS should not be dismissed just because gains are taxable and PPF is not. Besides, most salaried investors will already have EPF contributions so the tax-exempt safe investment is already taken care of. Why make additional investments in a lower-returning product through PPF? Yes, we’re comparing two different asset classes. But the reason we’re doing this is that from a tax-saving perspective, the choice is between the two of them. It is not from a debt Vs. equity perspective.
To begin with, PPF is a long term investment product aimed at building a retirement corpus. One can hold a PPF account till the end of life and earn tax free income at the same rate as a bank FD. At some stage in life, one would have to invest the accumulated corpus in ELSS fund in a fixed income instrument like a bank FD which offers steady monthly/quarterly income. Assuming the income tax rates and tax free nature of PPF remains the same as at present, one would require to accumulate in ELSS or any mutual fund scheme, a corpus at least 50.6125% larger than PPF corpus to earn the same post tax income from a bank FD, as the tax free income from PPF in case of assesees in the highest tax bracket. Comparison between PPF and ELSS should be over 15 years or more, in fact over entire working life of 30 to 35 years and not just over five years.. Over long periods, expected returns from equity markets should be restricted to GDP growth plus inflation i.e. no more than 12%, and that too taxable at 10.4% on redemption, except Rs.1 lakh. While ELSS may still score over PPF by a small margin, the safety of capital and certainty of return, though fluctuating quarterly now, gives a peace of mind that equity investment cannot. In any case, PPF is a debt product while ELSS is an equity product and so incomparable. Prudent investors should invest in both equity and debt and PPF is the best debt investment.
I understand your point of view, but I would like to address some points. First, ELSS can be held for a period of 15 years or more. Equity instruments are in fact ideal for such long-term periods.
Regarding regular income, PPF does not provide regular income either. Corpus built under PPF and ELSS will need to be switched into other products to generate regular income. These include a combination of Senior Citizen Saving Scheme, FDs, debt funds. You can use systematic transfers over 4-5 years to gradually move money from ELSS (or equity funds) into debt funds. There is no need to redeem the entire corpus at once. This will also help claim higher capital gains exemption limits and reduce tax outgo.
Historical comparison over a period of 30-35 years is neither feasible nor advisable. ELSS funds do not have that long a track record. Plus, equity and debt markets have matured over the years. PPF rates in the year 2000 used to be 15% p.a. It’s hardly likely to move to these levels again. Looking at that long a history will give you an incorrect picture. Anyway, take the last 15 completed fiscal years (2002-2017). For Rs 50,000 invested annually in PPF and Franklin India Taxshield, the end-corpus in ELSS works out to about Rs 47 lakh and PPF is Rs 15 lakh. The growth in ELSS is large enough that even post-tax, you would wind up with a much higher corpus. With repeated compounding, even a small difference in rate of return creates a huge difference in the value of the corpus.
You can invest in both PPF and ELSS. The point we’re making is that ELSS should not be dismissed just because gains are taxable and PPF is not. Besides, most salaried investors will already have EPF contributions so the tax-exempt safe investment is already taken care of. Why make additional investments in a lower-returning product through PPF? Yes, we’re comparing two different asset classes. But the reason we’re doing this is that from a tax-saving perspective, the choice is between the two of them. It is not from a debt Vs. equity perspective.