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Time to forget about PPF

Savers think of PPF as the old reliable workhorse of tax-saving, but this is a delusion that is losing them vast sums of money

Time to forget about PPF

If you're like most salary-earning Indians, then over fifteen years, you could have effectively lost Rs 62 lakhs on your tax-saving investments. This is not an exaggeration. This is literally what has happened to lakhs of us. What's worse, unless we understand what is happening, and take measures to stop it, it could continue happening.

So what has caused this Rs 62 lakh problem? The answer is PPF--which probably comes as a surprise to you. The Public Provident Fund is the mainstay of the voluntary tax savings that most of us do. For decades now, putting a chunk of money into PPF towards the end of March is a money ritual that practically every salary earner goes through. Unfortunately, the PPF is not a great investment. The other major alternative for tax-saving investments, ELSS mutual funds, provide far higher returns.

Consider this example. PPF has a lock in period of fifteen years, so let's take that as the period we consider. The maximum allowable investment under Section 80C is Rs 1.5 lakh. Over fifteen years, this adds up to an investment of Rs 22.5 lakh. If you invest this much over fifteen years, what would be the value of your investments be? To answer that, let's calculate using the interest paid by the government on PPF deposits over the past fifteen years. Over this time, these Rs 22.5 lakh would have grown to Rs 51.8 lakh.

What would have happened had we made the same investment in an ELSS tax-saving fund instead? Assuming we got just the average returns generated by ELSS fund over these years, the Rs 22.5 lakh would have grown to Rs 1.14 crore. You can read that number again and take a deep breath. Rs 51.8 lakh vs Rs 1.14 crore. 2.2 times the money. In fact, going forward, the scale will actually be larger, as the amount allowable as the annual tax saving under Section 80C will keep getting increased. The difference over the next fifteen years will actually be far more than Rs 62 lakh. There is no difference in the tax saving treatment between ELSS and PPF.

In the past, the limit was lower, so the difference would not have been Rs 62 lakh. However, the ELSS amount would still be 2.2 times that of PPF. So why doesn't everyone do this? For a lot of people, the biggest reason is probably lack of knowledge about ELSS. For decades, PPF has been the automatic choice for tax-saving investments for salary earners who have a low level of awareness about financial products and the options available.

Traditionally, in many places of work, the accounts department just informs every employee in January about how much PPF investment they need to make in order to avoid an extra tax deduction in March. There are salary earners who think that PPF is the only option that is allowed for this purpose. This probably happens because this actually used to be the case till the Union Budget of 2005, when the Section 80C limit had internal sub-limits. Till that time, only Rs 10,000 a year was allowed for ELSS funds.

Savers with somewhat more knowledge think PPF is better because it has fixed returns while ELSS is dependent on the vagaries of the stock market. In theory, this is true. However, given the long-term nature of these investments, the risk of ELSS funds underperforming PPF is negligible. Since 2000, the average returns of ELSS funds has been 13.34 per cent p.a. Incidentally, the best fund would accumulate 3.8 times PPF. Applied to our example above, the best fund would have generated Rs 1.97 crore vs the Rs 52 lakh of PPF.

There's a huge liquidity advantage to ELSS as well. PPF has a lock-in period of 15 years while ELSS is just three years, despite identical tax saving. This may sound heretical, but all things considered, savers should just completely ditch PPF and switch to ELSS.