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There is an eternal debate in
the investment advisory community as to which product should be
recommended for tax benefit u/s 80C. Product manufacturers will always
have their interest in promoting ELSS to shore up their collections but
it is upon investments advisors to make the right choice on behalf of
their clients. ELSS are excellent products for long term investment and
they provide tax benefit too. However, they have inherent risks too and
cannot be compared with a debt investment. While ELSS have excellent
track record and their future also looks promising, yet it may not always
outscore PPF. Here is why :-
Asset Allocation is important
It is important to suggest a
proper asset allocation to clients. Debt & Equity forms an important
part of asset allocation. All clients need to have some investment in
debt as part of their overall asset allocation as well as long term
savings. No matter who the client is, 100% exposure in equity is
dangerous.
Now, if some exposure needs to
be made in debt; PPF may be a preferred choice. It qualifies for tax
benefit at the time of investment and it provides tax free returns on
withdrawal as well on maturity. It also provides partial periodic
liquidity.
PPF is best among debt
instruments
If PPF is not considered as
the first choice for debt allocation (except emergency funds and other
short term needs), which other debt instrument comes close to it? In
fact, none. Tax free bonds offer much lower interest. FD and other bonds
are taxable. Debt mutual funds are close but non-guaranteed and taxable.
Though returns in PPF are falling off late, they still compare well with
FD rates. Considering tax benefits, they score much better. In future
also, it is expected that returns in PPF will be quite comparable with
other debt instruments. So, the question to ask is; if we are not
recommending PPF, which other debt scheme we are recommending for the
debt allocation of a client?
Exposure to EPF
If an investor has a big
exposure in employee provident fund and his debt allocation is being
fulfilled entirely from EPF, he may excuse himself from PPF. However, in
this case, the recommending ELSS against PPF also doesn't hold good
because the client may not even need tax benefit on investment. In such
case he can invest in non lock-in investments. It is seen that majority
of salaried individual's contribution is not much in EPF and they still
need to invest in other products for tax benefit. PPF then becomes the
2nd best choice.
Another situation where ELSS
may make sense is where an investor's total annual investment is up to or
below Rs.1.50 lacs. In this case a 50/50 ratio between PPF and ELSS may
be recommended as part of asset allocation strategy. Even in this case,
100% exposure in ELSS may not be the right thing to do.
ELSS vs PPF comparison is not
correct
We must compare apples with
apple. ELSS is equity, PPF is debt. So, the returns comparison is not
right. Also, assuming that a client will hold ELSS for 15 years is not
reasonable. Holding period of normal equity funds (which is just a few
years) can be good benchmark for this. When investors know there is
liquidity in ELSS after 3 years, it may be difficult to control their
behavior simply as it is difficult in case of normal equity funds in
which they invest thinking about 20 years but redeem much before even
though the advisor tries to convince them to hold. If they redeem ELSS
before, it entails risk for retirement corpus and/or long term savings.
Investor's behavior must also be taken into consideration while advising
on asset allocation and duration of investments.
Tax free status on maturity
ELSS currently enjoys Long
term capital gains benefit. However, it can go. While PPF also can lose
its tax free maturity status, there is a greater possibility that government
may maintain its EEE tax status for a much longer time in the future
considering the mass investors money invested in it.
Returns are not everything
Prudent financial planning
gives a lot of weight to risk appetite of client and proper asset allocation.
Though it is reasonable to expect that ELSS will outperform PPF over 15
years; still we can't expose our client to higher risk unless their debt
portfolio has been taken care of. Returns are important for not
everything. Asset allocation takes precedence over returns.
Commissions
Advisors don't make any
commissions by suggesting PPF whereas selling ELSS is lucrative and this
creates a conflict of interest. Still, we need to do what is best for the
client. If they are happy, they will eventually take care of us.
Conclusion
Each client is different. It
is upto the investment advisor to choose the right product for their
clients. ELSS are great products but a blanket recommendation of ELSS to
all clients against PPF may not be the best advice.
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