1-Tax saving investments and financial products: PPF, ELSS and more – Part 1

In this series of articles, I’ll try to cover the two very commonly used financial products widely used for Tax saving purpose. One of them is PPF or Public Provident Fund and second is ELSS or Equity Linked Savings Scheme.

Let’s begin with the description of the two and how they work:

PPF: PPF or Public Provident Fund gives you a long term investment horizon, 15 years (effectively 16 years). At the end of 15 years, you will get a lump sum amount. Hence, the first point to note is that PPF investment should be made only with the money that is extra with you, not the one that may be required in next 15 years. This leads to another point: PPF is an ACCUMULATION Scheme, not a regular income scheme.

Best of PPF:
• Lowest Risk – backed by government of India
• Tax benefit on invested money
• No tax on interest earned
• Compounded returns – the interest earned over the previous period is reinvested
• Flexibility of Investment: The minimum amount you can invest is Rs. 500 per annum and the maximum to a limit of 70,000 – major advantage is that you can select the investment duration – monthly, semi annually, or annually.
• No Taxation on withdrawal money on maturity
• Can be opened in any government banks, post offices and account transfer possible

Worst of PPF:
• Variable Interest rates: PPF appears to be risk free – the fact is that the biggest risk is variability of interest rates. PPF interest rates used to be as high as 12% at one point in time. Today it has come down to 8% - there may be changes in the rate and the government is the deciding body for PPF rate. It is possible that you start investing in PPF in 2001 when the rate was 9.5%. If, in 2005, the govt. decides to change the rates to 8%, then your investment will get 9.5% for 2001 to 2005, while from 2006 onwards interest will be calculated at 8%. Presently, the interest offered is 8%.
• Lengthy period of investment: If you decide to open a PPF account today, you will have to wait till the end of 15 years to get your money back. Though you have the option of withdrawing the money before the actual maturity period of 15 years, and also an option to take loan on your accumulated money in the PPF account, but there are limits and conditions attached to it. You have to go through a lot of paperwork and official process. The biggest drawback of a PPF account is that it is NOT a regular income investment; instead it is ACCUMULATION investment product – meaning that the money you invest remains unavailable to you for long time of 15 years.
• Interest calculation: This is an important point and many people are unaware of it. The interest is calculated on the minimum balance between 5th and the last date of the month. So make sure that whatever deposits you make, you deposit the money before 5th of each month, else you will loose the interest for that month.
• Withdrawing money is difficult: Even after maturity, the money invested takes a lot of time to be withdrawn – no reasons, other than it is controlled by government authorities. Same like pension money of EPF – people even have to pay bribes to get their money. However, things have improved a lot since the inclusion of banks and allow more transparency.

In essence, PPF should be considered only if you have extra amount of money that you do not need for next 15 years.

I want to give a word of caution regarding this “EXTRA MONEY” phrase. People keep on telling me that they are playing around in the investments market with the extra money that they don’t need. Do a self assessment whether the money is really extra or not. In the current lifestyle, majority of the individuals are laden with a house loan, car loan or other types of loan commitments. PPF or any other investment should be considered secondary. The first priority should be for pre-paying the loans and getting rid of it. As far as I know, the loans that you take, the interest is calculated on a daily or monthly basis, which results in a very high compounded value. Hence, If an individual is having a loan commitment, it is advisable that he gets rid of the loan as soon as possible, before considering any kind of investments – PPF, ELSS, stock investment, ETF, or whatever.



Continue to Part II