Introduction
The proper choice of investment opportunities in personal finance is extremely vital for achieving the goals set.
The sea of options available, however, carries their own characteristics, advantages, and risks.
Among two of the most popular investment options in India, Mutual Funds and the Public Provident Fund are at the top.
Even though both of them sound and good for wealth production with tax benefits, risks, returns, liquidity, and time horizon make all the difference between Mutual Funds and PPF.
Awareness of such differences will only empower an investor to take informed decisions according to his financial objectives, risk taking capability, and his investment time frame.
In this article, we have tried to dive into the details of both these investment options compared on all features, benefits, and the type of investor suited to each one of them.
In the process, we will discuss the importance of diversification and how both Mutual Funds and PPF can become integral parts of a well-balanced investment portfolio.
What Are Mutual Funds?
Mutual funds are investment schemes whereby the savings shillings of more than one saver are pooled together to invest money in a large portfolio of equities, bond, and all other forms of securities.
Usually, the professional Fund Managers are provided by an Asset Management Company that will be invested. Units owned by the owner are purchased upon entry whereby the value equates the underlined assets themselves.
This can be termed as the greatest benefit for mutual funds-one that brings to them numerous important benefits:
With mutual funds receiving funds from a significant number of investors, they are able to invest in assets diversified through asset classes, industries, and geographies.
This helps in reducing the possibility of risk that is associated with a particular class of assets and helps distribute the volatile effects. A range of tastes for investment, risk, and return.
There are funds of different types such as high-risk equity funds to aim at enormous capital appreciation as well as stable income through debt funds.
There are several types of mutual funds. These include:
• Equity Mutual Funds: This fund type primarily deals with stocks with a promise to yield high returns, though carrying higher risk.
• Debt Mutual Funds: The investment that is of fixed income generation type by way of security like bond. Its risk element is modest, and there are stable returns generated.
• Hybrid Funds: Those funds which are hybrid. Investments in those are both equity as well as debt. The element of risk gets balanced with returns.
• Index Funds: This serves to copy an aspect of the overall functioning aspects of a particular market tracking index like Nifty, Sensex or others.
• Sectoral Funds: This fund invests in one particular sector of the economy, such as technology or healthcare.
What is PPF?
Government of India promotes this public provident fund, which is a really good long-term saving scheme.
The Indian government has been promoting this and also assisted people to save money toward their retirement or long-term financial plan.
Interest that one accumulates in a PPF account is tax-free, and the amount at maturity together with interest so accrued is exempted under Section 80C of the Income Tax Act.
Interest compounded annually generates assured returns thereby helping in accumulating wealth over a period of time.
The lock-in period of the PPF is 15 years. Therefore, money deposited in the PPF cannot be withdrawn at any point in time before the close of the period.
However, partial withdrawal is allowed post-completion of the 6th year. The maximum permissible investment every year in a PPF account is ₹1.5 lakh. The minimum investment every year in a PPF account is ₹500.
Although the returns on PPF are not that high as on equity mutual funds,
they have stable and predictable return, and hence PPF is an attractive investment for those who are averse to risks.
Mutual Funds vs PPF
1. Risk and Return
Mutual Funds:
Mutual funds involve risk in every type of fund.
For example, an equity mutual fund bears all risks because of fluctuating markets but gives a much higher return over long periods of time.
Debt mutual funds invest in bonds and other fixed-income securities, so less risk-prone but give lesser returns.
It will take some time before equity mutual funds tend to outperform any other asset classes, giving a return of 12-15% per annum.
But the chances of losing money in the short run exist.
PPF:
This is an extremely low-risk investment as it has the guarantee of the government behind it.
PPF has its interest rate predecided and set by the government.
As a broad rule of thumb, these rates are in the range of 7% to 8% per annum.
Returns on this are guaranteed in no way correlated to market movements, and hence conservative investors look for it.
However, returns would be much lower compared to that of equity-based instruments like mutual funds, therefore having a lower ability to create wealth.
2. Liquidity and Lock-In Period
Mutual Funds:
One of the important benefits of mutual funds is liquidity.
Mutual funds, compared with PPF, allow an investor to sell units at any point in time as per the preference of the chosen type of fund.
The investment in mutual funds is primarily by open-ended mutual funds,
whereby the investors have the liberty of buying or selling units at the prevailing NAV, which does not place any constraints on the purchase or sale of units.
They would possibly be charged a capital gains tax that applies during the holding period.
For instance, for equities, they need to surpass one year before they can successfully achieve long-term capital gains tax,
and it can even be lengthier for the debt funds where the holding period is needed just to obtain their long-term tax benefits.
PPF:
PPF has a lock-in period of 15 years. That is, you cannot withdraw the money from your PPF account till the completion of 15 years, except partial withdrawals after the 6th year.
While partial withdrawals give some liquidity, PPF is not as liquid an investment as a mutual fund.
This long lock-in period serves well for retirement goals but would not be so suitable for short-term liquidity requirements.
3. Taxes
Mutual Funds:
Here also, it is the type of fund and holding period that dictate the treatment.
If it’s an equity mutual fund, capital gains tax would apply.
However, if the units sold within 1 year, then it would attract STCG tax at 15%.
Although older units can also be taxed as 10% long-term capital gains beyond ₹1 lakh in a year if sold after one year.
The holding period of debt funds is taxed, but the period of less than a year is taxed at a higher rate.
PPF:
PPF enjoys the advantage of a massive tax relief.
Investments made towards PPF under Section 80C of Income Tax Act can be claimed as a deduction.
Further, interest earnings are tax-free and so are the maturity proceeds.
So PPF has emerged as the most favourite investment option for investors not only for tax relief but also for assured returns.
4. Returns and Rate of Interest
Mutual Funds: The returns from mutual funds vary, dependent on the nature of the fund and overall market performance.
More often than not, an equity mutual fund fetches higher, but for that, one would have to face the risk that is accompanied by volatility as well.
However, a debt fund produces stable results; still, normally the returns are lower compared to equities.
Since mutual fund returns are not guaranteed,
they are a better investment option for long-term investors who do not mind seeing their money through short-term market fluctuations for more significant long-term gains.
PPF: PPF provides fixed and assured returns.
The government fixes the rate of interest for every quarter, which is uniform throughout the year.
The interest rate of PPF is at present around 7.1%, which, for a low-risk, government-protected investment, is one of the competitive rates.
The fixed return from PPF will, however not be that high if the returns may accrue in equity mutual funds in a booming market.
5. Investment Horizon
Mutual Funds
Investment horizons vary between short-term and long-term, but mutual funds are strictly a choice of the type of fund.
For example, equity mutual funds are ideal for long-term goals based on retirement or wealth accumulation because they carry more growth possibility.
Debt mutual funds would be best suited for those investors who have a relatively shorter time horizon and are seeking stable income with relatively lower risk levels.
PPF
PPF is a long-term investment with the compulsion to be locked for 15 years.
Though the investment can be extended in increments of 5 years after completion of the first term,
the product is highly recommended for persons with long-term savings objectives, which could be long-term retirement, savings for their children’s education, etc.
PPF is long-term in nature.
This facilitates compounding for an investor but those who have to liquidate the money might not find it a very lucrative option.
Diversification: Mutual Funds and PPF
The primary advantage of investing in mutual funds is the diversification process.
Mutual funds collect money from many investors, and the amounts are then put into a different kind of investment, including but not limited to stocks, bonds, and so on.
So, in short, this technique spreads the risks over a lot wider spectrum of investment, reducing an individual asset’s bad performance,
thus being effective in risk management, especially while investing in risky market conditions.
Unlike this, the same level of diversification cannot be found with PPF.
On one hand, being government-backed and being fixed income reduces exposure to volatility but has growth that cannot compete with diversified equity investment.
But then, the significance of PPF does not completely go amiss.
This product will fit quite well for those conservative investors wanting to take low risk yet providing a means to gain security as well as stability plus getting tax benefit advantages.
Both mutual funds and PPF would help an investor achieve a balanced portfolio, one with elements of growth and stability.
Obvious higher potential for growth is found in mutual funds, whereas the returns from PPFs would guarantee the investor their returns, plus tax-free interest coming back to them.
Sample Investment Scenarios
1. Investor A
Conservative investor who wants security and tax benefit.
Investor A is a retired person, who wants to invest some low-risk money so that he can save his money.
Most of his portfolio has been invested in PPF since he wanted to maximize ₹1.5 lakh so that he could be availing of the tax exemption from section 80C.
The tax benefits allow him for guaranteed long term tax-free income as returns in the long term and his capital was fully safeguarded with the investment.
2. Investor B
Aggressive,
With High Returns:
Investor B is a high-risk-taker and has long-term investment vision.
He would only focus on equity mutual funds having a high-risk nature because in the short run, the stock market can get quite volatile.
He is searching for huge capital appreciation over the next two decades and is very much comfortable with the ups and downs of the market,
understanding that the growth potential of the equity funds would eventually outweigh all risks in the long term.
3. Investor C
Conserved, seeking stability and growth
Investor C is of average risk-averse tendency and has long-term objectives in terms of creating wealth for his retirement and meeting his children’s educational expenses.
He selects both PPF and equity mutual funds.
By investing in it, he would be assured of the principal amount through PPF and get the growth aspects through equity mutual funds.
Therefore, he will obtain an optimal balance between risk and return.
Conclusion
Both Mutual Funds and PPF have different advantages and can be very valuable parts of an investor’s portfolio.
Mutual funds offer flexibility and liquidity with the scope for a higher return through market-driven investments,
but PPF would be offering a relatively low-risk tax-efficient option.
For the risk-seeking investor who requires more returns, mutual funds-in fact, the equity funds specifically-hold an immense growth potential.
But for the risk-averse investor who seeks security, stability, and long-term goals, PPF stands as a choice par excellence.
This decision of Mutual Funds or PPF is dependent upon the financial objectives, risk-bearing capacity, and time horizon of the individual.
An investment approach which is diversified between both, may help achieve financial goals of the investors while ensuring reduced risks.
It is critical to understand that what role every investment play in the portfolio in making a well-informed decision regarding investments.
FAQs
1. Is PPF better than mutual fund?
No, it varies with the needs of the investors.
PPF is a scheme that is low on risk and is therefore guaranteed by the government.
And since the income is assured to be there it is ideal to invest for old age savings security.
Mutual Funds are market Linked investments ( equity, debt which may give rich returns but risks are also bigger).
If your goal is stability and tax-free returns, PPF is better.
For higher growth potential and diversification, mutual funds are preferable.
2. Which plan is better than PPF?
There are other investment choices that may serve your goals more effectively than PPF:
NPS (National Pension Scheme): A retirement saving plan that provides tax benefit and long-term growth.
SIP in Mutual Funds: For wealth creation with better returns over the long term, though with higher risk.
Fixed Deposits (FDs): With lesser risk, but lower returns compared to PPF, although offering liquidity.
Stocks: If you are willing to take higher risk for potential higher returns.
3. Why is PPF not a good investment?
PP may not be the best fit for those looking at higher returns or liquidity.
The returns are less compared to equities or mutual funds. Lock-in period is 15 years, too long; therefore, not too liquid.
In case you want to have a more promising growth potential or flexibility, PP will not be the one that suits your need.
Is it good to withdraw PPF and invest in mutual funds?
It all depends on the risk appetite and your financial goals.
If generating more returns is desired, and such risks are manageable, then withdrawing from PPF and investing in mutual funds can be a good strategy for long-term wealth creation.
However, if your priority is guaranteed, low-risk returns, keeping your PPF intact might be better. It’s important to weigh your financial goals and time horizon.
4. Is anything better than PPF?
What you need to achieve utterly depends on the situation. If tax benefits and returns are concerned, nothing can get near PPF.
But for higher returns and long-term wealth creation, one might be talking about mutual funds, NPS, or even stocks.
It all depends upon the risk appetite, the aims of achieving that finance, and your investment period.
5. Which is better, NPS or PPF or SIP?
It depends upon the goals:
NPS is great for retirement savings with tax benefits and long-term wealth creation but has restrictions on withdrawals.
PPF is best suited for low-risk long-term savings with guaranteed returns and tax benefits.
SIP in Mutual Funds is best suited for wealth creation over time, but at a higher growth potential and the cost of risk and market fluctuations.
NPS will be better suited for retirement planning. For securing long-term savings with assured return, PPF is a good idea.
For generating higher returns on investments with moderate risk, an SIP in the mutual fund should be better suited.