#BQMutualFundShow: Want To Save Tax The Best Possible Way?
For everyone investing in Public Provident Fund, here’s the bad news.
For everyone investing in Public Provident Fund, one of the most widely used tax-saving instruments, here’s the bad news.
Rs 1.5 lakh invested annually for 15 years—because PPF investments have a lock-in of 15 years—fetched Rs 43.5 lakh. Tax-free.
No, that’s not the bad news. This is: the same amount, for the same duration invested in three of the worst-performing Equity Linked Savings Schemes, or ELSS, yielded Rs 67.8 lakh.
What’s ELSS?
ELSS is an open-ended equity mutual fund scheme which invests in stocks and is eligible for tax exemption under Section 80C of the Income Tax Act. The section allows an individual to invest up to Rs 1.5 lakh that is deducted from the investor's taxable income, saving about Rs 45,000 in tax (assuming the person falls in the highest tax bracket).
Limitations In ELSS Investing
Remember, money once invested can’t be withdrawn before three years. Even if you need the money urgently, it’s locked in and is not available even for a fee. So, invest only if you don’t need the money for at least three years.
Also, in shorter durations, say three years or so, ELSS performance can lag fixed deposits. Hence, invest in ELSS schemes as you would in mutual funds generally—for the long term.
Lastly, if your EPF (Employee Provident Fund contribution that’s deducted from monthly salary) is over Rs 1.5 lakh a year, you don’t need to invest in ELSS or any tax-saving scheme. That’s because your tax-saving has already taken care of by the EPF contribution. Just choose any of the other open-ended schemes for long-term wealth creation.
Happy Investing!
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We have evidence that PPF may save taxes and it’s a great instrument, but there are better things that can be done.
When people invest in PPF, their investment horizon is 15 years and you have to invest on a continuous basis. In the equity market, for 15 years, you have at least two cycles of ups and downs. So the returns even out. If you look at a 10-year return in mutual funds, it is close to 10 percent which is 2 percent superior to PPF return. If you look at 15-year data, then the worst 15 years numbers are between 12-13 percent. If you see average data for 15 years, they are anything between 15-20 percent. You are getting double of what you are getting in PPF.
One more challenging thing which people don’t appreciate is that in PPF, the rate of return is not fixed. It keeps changing on the basis the rate fixed by the government. The rate applies not only to your new contribution but also to your accumulated contribution. If the rate of interest goes from 8 percent to 7.9 percent, that will apply to whatever you have accumulated. The rates will come down further. It is not going to stop yet. If the government can borrow at 10-year G sec at 7.30 then why would they pay 7.80 or 7.90. The tax benefit and interest income are also tax-free. So, over a period of time, you will see PPF rate become more and more market linked.
If you look at the history of PPF, it is very interesting. The origin of PPF was that people who worked in the unorganised sector, who don’t have organized saving should invest in this kind of investment and secure their future. But it was completely hijacked by HNIs. There was a complete disservice to why PPF was created.
What is ELSS, and what should people keep in mind when choosing this instrument?
ELSS is Equity Link Saving Scheme. It is an equity mutual fund scheme. Any mutual fund which is registered with SEBI can launch an ELSS and almost every fund house has an ELSS scheme. It is mandatory for fund houses to keep 80 percent in equity at all times. Compared to all other investment options, ELSS has the shortest lock-in period, of three years. Bank fixed deposits have a five-year lock-in period, insurance has a longer lock-in period and PPF has 15 years’ lock-in period. When you buy an insurance product, you buy just one insurance product. In ELSS, you can diversify your Rs 1,50,000 in 10-15 mutual fund scheme.
Secondly, you don’t have to commit yourself. When you buy an insurance product, you have to commit that you will contribute, say Rs 1 lakh per annum, for 5-20 years. In ELSS there is nothing like it. Suppose you lose your job and don’t have an income, then you don’t have to contribute. So, it provides better flexibility. The lock-in is the lowest among all the tax-free available option. It is far more easy and convenient to invest. There are fewer strings attached to it. For an investment performance perspective, for a longer period of time, we haven’t seemed any instrument which comes closer to ELSS as far as performance is concerned.
Are there other instruments which lie between ELSS and PPF?
Nothing beats PPF. Bank deposits, interest rates are 6-7 percent and PPF gives you 7.8-9 percent. In bank deposits, interests are taxable. In PPF, interest is tax free. In insurance product, in endowment plan the returns are 5-5.5 percent and you commit for a long period. In ULIPs, the charges are a question mark. Among other things, you have a postal scheme, an EPF product, you have housing loan. But among all them, PPF is the second-best option. The number one option is ELSS, provided you are willing to invest for a longer period.
How can somebody buy an ELSS scheme?
It is as simple as buying a mutual fund product. It has a mandatory three-year lock-in and you can’t take money out. The way you buy a normal mutual fund product, either you buy through an advisor or direct, options are available.
Our advice to investors is when you buy ELSS, don’t buy only one scheme. Look at least 3-4 schemes because the performance has not been consistent with all fund houses. The scheme which has done very well may not necessarily replicate the performance going forward. When you are more diversified with 3-4 schemes, you are comfortable to get average kind of return or else you could have a super return or lousy return. It is specific to all mutual fund schemes.
Many advisors say that you should not be too diversified too much. I am not a proponent of that. I believe that if you are buying a mutual fund product, no fund house is 15 percent of your total corpus. The performance divergence is so much, and it will increase further as we go along. If you look at last 1-3-year performance, if I say take five names, then none of the schemes will be in top five performing scheme. So, it is very important to diversify across the style, the fund house, and fund manager. Many time people buy two products from the same fund house, if it is managed by different fund managers then it is good. Else it doesn’t make any sense. People take a divergent view. Even in leading fund houses, one fund house has positioned their scheme very differently than from other fund houses. So, you should have at least eight schemes in a portfolio.
The earnings are tax-free after the lock-in period. Can you elaborate?
The earnings are tax-free after one year, but you can’t take it out. The dividend is tax-free. If you invest in ELSS and dividend option, the dividend is tax-free. So, that cash flow comes in your hand. But I don’t recommend any investor to opt for dividend scheme in any equity oriented scheme because it destroys the long-term wealth creation opportunity. After three years, as the tax law exists today, your entire corpus is exempted from tax.
Suppose you invest Rs 1,50,000 today, after three years it becomes Rs 3 lakh rupees. Then you take out Rs 3 lakh. Rs 1,50,000 on which you got 30 percent tax rebate -- on Rs 1,50,000 the entire gain is tax free. This is a general illustration.