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PPF v/s Mutual Funds: Which Is Better? - Outside View by PersonalFN

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PPF v/s Mutual Funds: Which Is Better?
Jul 10, 2018

My sister is a conservative investor. Recently she checked her PPF account balance and was amazed to see the interest income earned. She started making plans for directing more funds to her PPF account this year. The money in a bank account in front of her own eyes gives her a sense of security.

But I feel it is unwise to stack a big chunk of money into PPF account for my long-term goals. I would rather invest in mutual funds which earn better returns, offer better liquidity and host of other benefits.

So, I explained my sister the importance of long term investing in mutual funds.

Assuming she invests Rs 1.5 Lakh annually for a period of 15 years, equally in both PPF and mutual funds. Contribution to PPF account would add up to the value Rs 42,95,333.

And if she invests Rs 12,500 in mutual funds via Systematic Investment Plan (SIP) every month for the period of 15 years, the value of her investment assuming 12% CAGR would be around Rs 63,07,200.

I know what you are thinking! And yes, it not always about the returns earned.

Let's find out - PPF v/s Mutual Funds Which Is Better?

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Definition

Public Provident Fund (PPF) is a government backed, long-term small savings scheme. You can make contributions of up to Rs 1.5 lakh each financial year. These contributions are locked in for a period of 15 years with partial withdrawal facility.

The government initially started it to provide retirement security to self-employed individuals and workers in the unorganized sector.

But now it has become one of the favorite investment avenues from tax savings point of view.

A mutual fund scheme, as the name suggests, is a shared fund that pools money from multiple investors and invests the collected corpus in shares of listed companies, government bonds, corporate bonds, short-term money-market instruments, other securities or assets, or a combination of these investments.

There are different types of mutual funds some are categorized on the basis of their asset allocation, investment style, and so on. They are broadly classified as equity mutual funds, debt mutual funds, and hybrid mutual funds. These are further classified into sub-categories.

Watch the video on Types Of Equity Mutual Funds

Source: PersonalFN

Lock-in Period

Since PPF account scheme is targeted as a retirement savings product, the money is blocked for 15 years. With a 15-year lock in, this is the longest horizon for an investment that exists in India.

Most of the mutual fund schemes do not have a lock-in period. Schemes can be classified broadly as open-ended and close-ended.

Open-ended funds are available for subscription throughout the year. And close-ended funds offer a stipulated maturity period, e.g. 3 years, 5 years, etc., at the time of launch.

When you investments in Equity Linked Savings Scheme (ELSS) --also known as tax saving funds--- the amount is locked for three years, but you enjoy a tax benefit upto Rs 1.50 lakh under Section 80C of the Income Tax Act, 1961.

[Read: Everything You Need To Know About ELSS]

Hence, from a liquidity vantage point most of these mutual funds are highly liquid as compared to PPF.

Rate Of Interest

The PPF interest rate is benchmarked against the 10-year G-Sec yield and it is usually 0.25% higher than the average yield on G-Secs. The current PPF interest rate as on January 2018 is set at 7.60%.

Now, rate of return on mutual funds is not fixed. It is market-linked and varies from one scheme and category to another. But equity diversified funds like ELSS generate around 10%-15% rate of return per annum over a period of 3 - 5 years.

Though you earn fixed rate of return on your PPF contributions, the returns are not enough to fight the inflation bug over the long term. On the other hand, an ELSS turns out to be better option as they earn higher returns (Potentially can generate compounded annualized growth rate of around 12% - 15% p.a.; but the key lies in selection of the scheme).

Also, if you are risk averse, then you can opt for debt mutual funds. Depending upon your goals and investment time horizon you can chose a particular debt fund.

Watch this video on Types And Basics Of Debt Mutual Funds.

Source: PersonalFN

Tax Treatment

PPF enjoys Exempt-Exempt-Exempt status.

In other words, the contributions (i.e. investments) made to the PPF account up to Rs 1.5 lakh is eligible for tax deduction under Section 80C in a financial year, the interest earned, and the maturity proceeds are exempt from income-tax.

From a taxation angle, PPF definitely has an edge over mutual funds.

Tax treatment for mutual funds varies from one scheme to another. As mentioned before, investments up to Rs 1.5 lakh in ELSS funds is eligible for tax deduction under Section 80C. But to invest in other equity funds and debt funds, there is isn't a tax benefit.

Mutual funds are taxed on two terms - capital gains and dividend.

Furthermore, the holding period of debt and equity mutual funds is separately categorized as below.

Fund Short-term Long-term
Equity Mutual Fund Upto 12 months More than 12 months
Balanced Mutual Fund Upto 12 months More than 12 months
Debt Mutual Fund Upto 36 months More than 36 months

In case of debt mutual funds, Short Term Capital Gains (STCG) is taxed as per your tax slab and Long-Term Capital Gains (LTCG) at 20% after indexation.

[Read: How LTCG Tax On Equity Investments Can Derail Your Financial Plan]

Likewise, when you invest in a debt mutual fund scheme vide a SIP and stay invested for holding period of at least three years, although the capital gain is taxable, you enjoy a indexation benefit (for inflation) and the LTCG tax payable is @20%.

This is far better than paying tax as per your tax slab, particularly when you're in the highest tax bracket.

Capital Gains Tax Dividend Distribution Tax
Short-term Long-term
Equity Funds 15% 10%* 10%
Aggressive Hybrid Funds 15% 10%* 10%
Debt Mutual Fund As per your income tax slab 20% with indexation 28.84% (25% + 12% surcharge + 3% cess)
*on gains over Rs 1 lakh

Prior to April 01, 2018, long term gains earned on equity mutual funds were tax-free. But under the new tax regime LTCG earned above Rs 1 lakh will be taxed 10% without indexation, while for STCG the tax rate applicable for 15% tax.

Further dividend declared on equity funds will attract 10% tax.

Withdrawals

Your contributions to PPF account are blocked till maturity, i.e. 15 years. But partial withdrawals are any time after the expiry of the 5th year from the date that the initial subscription is permitted.

You can withdraw an amount of not more than 50% of the previous year's balance or of the 4thyear immediately preceding the year of withdrawal, whichever is less.

For example, if you opened your PPF account on April 1, 2014, you can make your first withdrawal after April 1, 2020, and the amount of withdrawal will be limited to 50% of the balance as on - March 31, 2016, or the balance as on - March 31, 2019, whichever is lower.

Thereafter, you can make one withdrawal per year.

It is important to note that, if you have taken any loan on your PPF account, this also gets factored in and reduces your balance.

In case of mutual funds, withdrawal rules vary from one category to another. Apart from the funds with fixed maturity or lock-in, there is no restriction on redemption. You are free to redeem your mutual fund units at any given point. But before you redeem your units, keep in mind the tax implications and exit load.

Definitely, mutual funds offer better liquidity.

Investment Limit

It is mandatory to make a minimum contribution of Rs 500 per year and a maximum of up to Rs 1.5 lakh per annum in a PPF account. Both, lump sum and monthly contributions are allowed, but cannot exceed 12 transactions in a year.

In mutual funds, there is no upper limit to your investments. And you can start investing via SIP with amount as low as Rs 500.

But the minimum and maximum investment limit may vary with each scheme. For instance, Fund A may have minimum investment criteria of Rs 1000, while Fund B Rs 5000.

Similarly, some mutual fund schemes may have set maximum investment limit. You can find out these details in Key Information Document (KIM) and Scheme Information Document (SID) of the respective scheme.

[Read: What You Should Read In A Scheme Information Document]

To Conclude - PPF vs Mutual Funds

Both investment avenues are unique.

But investing in mutual funds can prove to be a rewarding experience, provided you take enough care to select best mutual funds for your investment portfolio.

[Read: Willing To Take Some Investment Risk? Mutual Funds Are Your Best Bet]

There are various categories and sub-categories of mutual funds to choose from depending on your needs, investment objective, time horizon, and risk profile.

To address your vital long term financial goals viz. child's future needs (education and marriage) and your own retirement, diversified equity mutual funds would be apt to generate an efficient real rate of return (also known as inflation-adjusted returns).

And if your goal is tax saving, ELSS turns out to be a better option, provided you have the stomach for high risk. It has a shorter lock-in period and generates better real returns over the long-term.

The choice is yours, so make it wisely.

Happy Investing!

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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