At present, there are a lot of investment options for the ordinary investor to save tax. Some of them being mutual funds, public provident fund or PPF, Unit Linked Insurance Plans (ULIP), fixed deposits among others.

Moreover, the recent market correction and volatility has brought about doubts in the minds of many investors. The doubt is – in terms of investment options, which should be the optimal choice for an average investor?

Mutual funds have been a hot potato, in recent times. This investment option has witnessed an inflow of approximately ₹15,000 crore per month into mutual funds in the past 1 year. The investors have been relying on mutual funds since equity and mutual funds had been providing excellent returns.

Post this market volatility, the investors are re-considering alternate investment classes which are less- risky, without compromising with the returns.

Update: The present PPF rate is 7.6%.

Unit Linked Insurance Plan (ULIP)

ULIP merges the idea and concept of investment with insurance.

How ULIP does so? It’s simple. The money put in this scheme is divided into 2 parts. One part goes into insurance and the remaining portion goes into investment (this investment is very similar to equity investments in mutual funds).

The investors can also choose their own investment horizon, be it 5-10-15 years. However, the minimum investment horizon in case of ULIP scheme is 5 years.

Charges for ULIP are capped by the IRDAI at 4% for policies with a tenure of up to 5 years, 3% for policies with a tenure of up to 10 years and 2.25% for policies with a tenure of greater than 10 years.

Investment in ULIP can be deducted from your taxable income under Section 80C.

Charges under ULIP are divided into various heads being premium allocation charge, policy administration charge, mortality charges, fund management charges and surrender charges.

This capping makes the total charges for ULIP low.

ULIP as an Investment

ULIP scheme offers to the customer an opportunity to invest in stocks, mutual funds or bonds. The investment is governed by the customer’s risk-taking ability and return expectations.

Out and out these options may seem very appealing, however, the majority of the ULIPS are expensive and the charges deducted are quite high.

Moreover, as the investment is always subjected to the market fluctuations, ULIP had the same amount of risk as any other investment, be it in equity, mutual funds or others.

ULIP as an Insurance

ULIP as an insurance plan is often considered by a class of people who are ready to take risks. This is contrary to the general or traditional approach for taking an insurance scheme.

The traditional insurance plans provide benefits like risk cover, fixed income return, safety and tax benefit and cater to people who have no liking towards risk.

Categories of ULIP

ULIPs can be divided into three categories based on the returns and distribution in equity and debt securities-

Balanced High Equity ULIPs

These schemes have a high equity allocation, thereby providing high returns to the investors.

Similar to the balanced mutual funds, the high equity ULIPs in this category also have funds managed in such a way that a significant portion of the investment is allocated to equity securities whereas a smaller amount goes to debt securities.

Balanced Moderate Equity ULIPs

Most plans that have a reasonable amount of investment fall under this category. The allocation of investment for debt and equity is set at either 50-50 or more. However, more often than not, stock distribution is limited to 70 percent or less, and hence forming a moderate equity ULIP.

Balanced High Debt ULIPs

Balanced High Debt ULIP is one of the safest plans on the market as the distribution has a high percentage of cash related securities.

Public Provident Fund

PPF is one of the most widely opted investment schemes in India. This is mostly due to the savings plus tax benefits that it provides. As the scheme is backed by the Central Government, it is very safe; thereby making it all the more attractive.

Provident Fund is a long-term savings investment options established by the Govt. of India in 1968. It intends to inculcate the habit of savings amongst Indian citizens for their life after retirement.

The scheme is backed by the Govt. of India and there are no chances of capital erosion. It also gives guaranteed returns which are related to G-secs.

The tax benefits provided under this scheme comes under the exclusive EEE or exempt- exempt- exempt status. This means that the investors’ money is exempt during all the stages of investment lifecycle. Elaborating, the investment is exempt from tax at the time of investment, the interest earned as well as at the time of maturity.

Investment in PPF can be deducted from your taxable income under Section 80C.

PPF requires a minimum contribution of Rs 500 per year and maximum of Rs 1.5 lakh per annum is allowed.

One of the main features of this scheme is a lock-in period of 15 years. It provides an interest at the rate of 7.9% for the FY 2017-18 (subject to change by notification).

Mutual Funds (Tax Saving\ELSS)

A mutual fund is a collection of stocks or bonds or other assets that a professional fund manager manages on behalf of a mutual fund investor.

The fund manager creates a portfolio of investments as per the category in which the fund belongs to like equity oriented mutual funds invest majorly in equities. The category of the fund is determined by the investment objective, risk and return magnitudes.

Investors may invest in mutual funds as they don’t have the expertise, time and energy to generate above-average returns (greater than the benchmark).

There are three broad categories of Mutual Funds

  • Equity – Investment in equity funds have the potential to generate high returns. However, these also have a comparatively higher risk.
  • Debt – Investment is debt funds are safer than an investment in equity funds. However, the returns are also lower.
  • Balanced – These invest a portion of equity and rest in debt. Therefore they bear moderate risk and give moderate returns.

Systematic Investment Plan (SIP) allows an investor to invest a small amount of money periodically into a mutual fund scheme.

SIP enables an investor to cope up with the market volatility. It comes with a benefit of rupee cost averaging. It enables common people with low savings/ funds to become a part of the investor community and take part in capital appreciation.

Equity Linked Savings Scheme or ELSS is a type of mutual fund wherein a major portion out of the total fund is invested in equity and related products. As evident from the name of the scheme, it comes with benefits attached to it, in the form of tax savings.

ELSS comes with a lock-in period of 3 years, therefore any premature withdrawals are not allowed. These schemes come with tax savings of up to ₹1,50,000 under section 80C of the Income Tax Act.

PPF vs Debt Mutual Funds

Both PPF and Debt mutual funds have something in common in terms of lower risk and considerable safety. However, they differ with each other on a lot of aspects important for a common investor.

The following table helps us to understand certain points of difference between PPF and debt mutual funds-

ParametersDebt FundsPPF
RiskLow to mediumNil
ReturnsMarket linkedFixed
TaxationApplicableExempt-Exempt-Exempt
Liquidity100% liquidLow
Lock-in periodNil15 years

Thus we see that Debt funds usually provide higher returns and do not have a lock-in period. PPF on the other hand, are highly illiquid funds with a lock-in period of 15 years.

The decision to invest in either of the funds will depend upon the investment objective of the investor. These funds are fundamentally very different from each other.

PPF vs ELSS

ParametersELSSPPF
ReturnsMarket linked and Equity orientedFixed
TaxationApplicableExempt-Exempt-Exempt
Liquidity100% liquid after 3 yearsLow
Lock-in period3 years15 years

In a comparison between ELSS and PPF, we see that whereas both these investment schemes have a lock-in period, ELSS has a much shorter one.

However, whereas ELSS has higher return potential as the returns are linked to the market, they also come with taxation in the form of long-term capital gains.

All in all, ELSS serves as a comparatively better investment alternative because it provides higher returns to its investors and is more liquid as compared to PPF.

PPF vs Equity Oriented mutual funds

ParametersEquity Oriented mutual fundsPPF
RiskMedium to highNil
ReturnsMarket linkedFixed
TaxationApplicableExempt-Exempt-Exempt
Liquidity100% liquidLow
Lock-in periodNil15 years

Equity-oriented mutual funds provide higher returns to investors and also have higher risks as compared to PPFs. The returns from equity oriented mutual funds are taxable, but these funds come with no lock-in period and thus are highly liquid in nature.

All in all, an investment in either mutual funds should ideally be guided by the investment objective, coupled with the risk-return appetite of the investor.

Both these investment options serve a very different purpose. Investors who are looking for capital appreciation in the long-term whilst taking some risks may opt for mutual funds over PPF.

ULIP vs Mutual funds

ParametersMutual fundsULIP
ScopeInvestment onlyInvestment plus insurance cover
RiskLow to highLow
ReturnsMedium to highLow
ChargesLowerHigher
TaxationTaxable. Deduction under S.80C available up to ₹150,000 for ELSSDeduction under S.80C available up to ₹150,000
LiquidityMore liquidLess liquid
Lock-in periodNil5 years

 Mutual funds and ULIP are totally different schemes with totally different objectives.

If the investors are looking for only capital appreciation in the medium to long term then mutual funds are a better alternative. They provide higher returns and are more liquid in nature as compared to ULIPs.

ULIP also provide insurance cover apart from the investment. These funds have a minimum lock-in period of 5 years and thus are less liquid. The returns are comparatively lower since the purpose of this scheme is to keep the total risk low.

Investors also have the option of investing in an insurance scheme and investing in a mutual fund separately. It depends upon the objective of the investor and the case being subjective may vary from person to person.

Conclusion

While many people may feel that ULIP are good products for they are getting two products at one’s cost. But it is very important to understand that investing in ULIP is a sub-optimal investment strategy.

Furthermore, insurance covered under ULIPs are mostly not sufficient.

For most of the people, it is wise to invest in term insurance and mutual fund separately. They shall offer both the advantages of ULIP and minimal risk.

ULIPs could be more suited for individuals with a long-term financial plan of wealth creation and insurance. The goal could be retirement, children’s education or personal financial goals.

A ULIP scheme gives its investors the dual benefit of savings and protection, all in a single plan.

Moreover, ULIP’s are for individuals who are not savvy with the equity market or different fund options available with mutual funds but would like to benefit from long-term capital appreciation with investment in equities.

Happy investing!

Disclaimer: The views expressed here are of that author and may not be same as that of Groww.