“Bank Fixed Deposits are not going to work for me! I am planning for building up a fund for paying off my daughter’s college fees.” Mr. Iyer was telling me the other day.
“I want to know where I can invest for 5 years so that I would be able to pay off the college fees easily after 5 years?” Mr. Iyer was indeed worried because he is not able to understand how to work this out.
Mr Iyer is a representative example of the common man to whom any of us can relate to. There are so many financial instruments in the market, then how to choose the correct one suited for our financial goal. Let’s see in this case study where Mr Iyer can invest fruitfully for 5 years in ELSS vs PPF Public Provident Fund
Let’s understand what are ELSS (Equity Linked Saving Scheme) and PPF (Public Provident Fund)
ELSS refers to Mutual Funds that invest 80% or more in equity i.e. shares and securities. ELSS is one of the primary tax saving instruments which has a lock-in period of 3 years. Investors can invest in ELSS in a lump sum or through SIP (Systematic Investment Plan). SIP requires that the investor should invest a fixed monthly amount in a selected ELSS fund.
Read more about ELSS Funds – 7 Reasons Why ELSS Has Evolved Into A Popular Tax Saving Alternative
PPF refers to another tax saving instrument which is a rather long term investment term of 15 years. The investors would be required to open a PPF account wherein he is required to invest monthly or annually.
The differences between ELSS and PPF
|Lock-in period||An investor needs to stay put in ELSS for the minimum period of 3 years to get a tax deduction benefit on the investment under section 80C||Lock-in period for PPF is 15 years which is much higher as compared to ELSS.|
Even though partial withdrawal is allowed after 5 years, substantial money will still be blocked till maturity.
|Liquidity||Due to 3 years lock-in period, the investor can easily redeem or sell to quench its liquidity needs||Due to greater lock-in period, PPF can be touted as an illiquid instrument, more suited to long term financial goals like retirement planning etc.|
|Returns and risk ratio||ELSS has a moderate to higher risk and returns ratio since 80% or more of the funds are allocated towards shares and securities in the open market. Returns could be on an average 10-13% p.a. The risk could be in the corresponding % due to market uncertainty||PPF has a lower risk-return ratio since it is a government scheme. Returns could be around 7-8% as dictated by government. Risk is very less since the returns are guaranteed by the government|
|Taxation||Investment in ELSS is covered under section 80C deduction, however, the capital gains are taxable above the limit of Rs.1 lakh||PPF has an EEE structure meaning that investment, returns, as well as maturity proceeds, are exempt from the income tax purview.|
Let’s compare ELSS and PPF for Mr. Iyer
I showed all this data to Mr. Iyer who was again confused, “Anna, it looks like both ELSS and PPF have their pros and cons. How would I know which one is better for me?”
So here is the comparative chart where it is assumed that Mr. Iyer invests Rs. 5000/- per month in ELSS and PPF.
|Year||The amount received annually if Rs.5000 invested in ELSS||The amount received annually if Rs.5000 invested in PPF|
*assuming that ELSS earns a rate of return around 11.5% and PPF earns around 7.1%
Analysis of the case study
- Looking at lucrative returns earned by the ELSS, ELSS definitely makes a good option for a 5-year investment option
- However, while considering the higher rate of return, we also must attach the risk carried by ELSS in the form of unguaranteed returns and loss of principal.
- PPF returns even if secure and easiest way for investing, definitely takes a toll on the liquidity stature of the investor. Since PPF allows only partial withdrawal after 5 years, there is no chance that Mr. Iyer could take out money before that threshold.
- PPF is the most secure form of investment since it is backed by the government. Even if the rate of return does not factor in the inflation cost, there is no default risk or market risk in PPF.
- If we keep on populating the returns for both ELSS and PPF for a longer period, ELSS would bag the surge in returns in the long term considering that markets will be in the progressive mode of operation.
I suggested Mr. Iyer take an independent decision based on the below pointers. Hope it helps you all too to take a big leap.
- If Mr. Iyer wishes to conserve the capital and is wary of the stock market, then he can put his money in PPF. This would give him the guaranteed returns and security of principal invested. However, the con side to this would be
- Comparatively lower returns
- No inflation factoring of returns
- The long term Lock-in period of 15 years resulting in a liquidity crunch
- If Mr. Iyer has a moderate to high-risk appetite, then he can think of putting his money into ELSS funds to secure a higher rate of return. ELSS would be a very liquid asset as well as a high return bracket. However, there are few risks to think of
- Loss of principal due to market risk
- Unguaranteed returns
- Alternatively, Mr Iyer can divide his investment in PPF and ELSS to reap higher returns and square off the losses.
Equity Linked Saving Scheme can serve as the ideal option for those investors who wish to benefit from tax savings and better returns in the long run. Coupled with a drastic growth in its popularity over the last few years, a large number of misinformation has developed surrounding its operations. Today we are going to educate all potential investors about the advantages associated with making ELSS investments in stark contrast to other tax-saving options such as PPF or NPS.
One of the very first things we enquire about an investment vehicle is the rate of return it promises to shower us with on the passage of a considerable time frame. In comparison to other tax saving options providing between 5-8% return, ELSS funds that invest mostly in equity schemes provide between 10-15% returns. The benefit of compounding joins hands with returns from equity to provide investors with higher returns in the long run. Favorable scenarios arising in the stock market which is highly probable in a growing economy like India can help you in reaping greater returns with a carefully constructed portfolio. Investing discipline as we all know is the key to benefitting out of good returns and this is taken care of in the best way by the three-year lock-in period which paves the path for higher yields.
Related Article : FD vs. ELSS – Where does Mr. Gupta invest and why?
While Public Provident Fund (PPF) comes with a 15-year lock-in period & NPS cannot be redeemed before retirement. ELSS funds on the other hand can be redeemed after the passage of just 3 years which surely is the shortest amongst the financial instruments which qualify for 80C benefits.
Power Of Compounding
Investing discipline as we all know is the key to benefitting out of good returns and this is taken care of in the best way by the three-year lock-in period which paves the path for higher yields. However, for better returns, it is advisable to stick to your investment over a span of 5-10 years.
Mutual fund investment has become highly transparent off late with the inclusion of KYC procedures and investor protection guidelines. Since all mutual fund companies operate under the purview of SEBI and are thus under an obligation to make necessary disclosures, you can be completely guaranteed the safety of your ELSS investment.
ELSS funds can be redeemed after the passage of 3 years from the date of investment if investors are not satisfied with the rate of return. Alternatively, they can carry on with the investment plan with no upper limit on the tenure.
Related Article: Retirement through Equity Linked Savings Scheme
Systematic Investment Plan serves as one of the best available ways of instilling investor disciple through regular investment and ELSS schemes can provide them with the option of benefitting out of the same over the long-term horizon. With monthly investments possible at just 500 INR, you can easily turn your savings into investments by riding on the ELSS vehicle. In this way, a salaried individual can invest a portion of his salary periodically for benefitting out of compounded returns.
The amount invested in ELSS can be claimed u/s 80C as a tax deduction up to the maximum limit of 1.5 lakh INR. In spite of having a lock-in period of three years, ELSS returns are considered as long-term capital gains (LTCG). However, in stark contrast to short-term capital gains (STCG) which is subject to a 15% tax levy, LTCG is subjected to 10% taxation if the gain amount exceeds 1 lakh INR.
ELSS investment is completely paperless in nature thus allowing investors to engage in the same even by using websites or mobile applications. Even payments can be done through debit cards and net-banking after which investors can track, invest further or redeem their investments by sitting at the comfort of their home. ELSS mutual funds is the ideal choice for everyone who wish to save tax while maximizing returns.
Retirement Planning through Equity markets, really? Sounds pretty much like you won’t be thinking is possible, right? But what if I tell you that Retirement Planning through ELSS is very much possible and optimal option.
Let’s see why you should plan for your retirement first.
Why there is a need for Retirement Planning?
We enjoy and spend as much as we can afford when we are earning in our youth. But what happens when we retire and we don’t have an active income source which would be accruing and can be used for settling the commitments?
Retirement Planning helps us deal in a financial sense with the Post retirement expenditure and Lifestyle requirements as mentioned below :
- To maintain the current standard of living even after retirement
- To manage the increased burden of medical expenditure
- To allocate and mark up funds arrangement for vacation planning
- To maintain independent financial health and plan for succession
What is ELSS?
ELSS refers to Equity Linked Savings Scheme which means the mutual funds which invest primarily in Equity or stock market.
- ELSS allocate their 80% funds towards stock markets or equity instruments
ELSS are actually called Equity Linked since most or all of the money of the investors is invested in shares and securities.
- ELSS have tax benefit on investment
This means that investors can opt for tax deduction under section 80C for the amount invested in ELSS. If you redeem the ELSS after the expiry of lock-in period, then the proceeds will also be exempt from Income tax if the gain is less than 1 lac. Otherwise 10% of gain needs to be paid as taxes.
- Lock-in Period of 3 years
Since ELSS are tax-saving instruments, they come with a lock-in period. Once you invest in ELSS, you block your money for 3 years at least if you wish to save on tax.
- ELSS earn more than your regular deposits
Bank deposits are yielding lower interest rates right now and the Stock Market is beaming high. Even where all the ups and downs are considered, a decent wealth-building plan would definitely earn you more than Fixed deposits.
Related Article : FD vs. ELSS – Where does Mr. Gupta invest and why?
- Invest in SIP or in Lumpsum
You can opt for SIP route where you will investing in ELSS monthly or you can invest aa single amount in a lump sum.
- ELSS does not provide stable returns
Having said that ELSS earn more, it is because of the fact that these are based on the dynamic stock market. ELSS will not provide you fixed income however, you can decide to invest in ELSS based on various parameters which can give you leverage over this risk.
How can ELSS and Retirement Planning go hand in hand?
- ELSS allows you to track the value and much more at any time
Investors can easily track the value of their investment and the NAV of their investments at any point in time when they opt for ELSS. This allows them to check whether their funds have underperformed or are at optimal levels.
- ELSS helps you switch to other funds too
If you are unhappy about the performance of ELSS then you can use the switch option to divert your fund to the most eligible option, subject to conditions. This is possible in the same AMC and only after the lock in period is over.
- ELSS are professionally managed
Investors having an urge to invest in stock markets due to its lucrative returns, often back off due to lack of knowledge. However, ELSS helps you deal with this insecurity since those are managed by the qualified and experienced Fund Managers
- ELSS are transparent
All information related to inception, their composition, fund managers, returns, other parameters etc. is always available on public domain w.r.t ELSS. So there is nothing which is hidden about the ELSS.
What should you consider while doing Retirement Planning through ELSS?
- Expense Ratio
Expenses ratio refers to the expenditure with respect to the administrative structure which also includes a fund manager’s salary. ELSS with lower expenses ratio will always earn more just because the actual return earned by the fund is little eaten off by the costs of the ELSS fund management.
- Benchmarking of performance
This is a tricky one since the ELSS performance should always be compared with
- Its own historical performance
- And peer performance
These two criteria will always allow the investor to filter out the best ones.
- ELSS has dual advantages of tax saving and wealth building
ELSS are a very optimal investment option considering that it allows you to reap tax benefits as well as helps in wealth building. If you select an appropriate ELSS then you are sure to get inflation factored returns.
- AUM (Assets Under Management) and their composition
This data is always available on the public domain, so it is advisable that one should check these before investing in the same. Higher the size of AUM, greater are the chances of higher returns on the same.
Even with all these, ELSS is the most favourite tax saving instrument and can also be used as a tool for Retirement Planning. However, you will always need to check the corpus of retirement funds, desired ROI, Inflation rate impact and tax benefits. And once you are done with the evaluation, you should always jump in at the right moment to start earning early with ELSS.