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EPF vs. mutual funds: which is better?

Posted on 02 Jul 2023
Author: Sayan Sircar

Tags: Choosing Investments

7 mins read
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The article presents a historical analysis of investing in stocks vs. EPF since 1979.

Many investors wonder which is a better option for long-term investment: Employee Provident Fund or investing in the stock market via mutual funds.

📚 Topics covered:

Historical interest rate of EPF
Making a monthly investment in stocks vs EPF
Conclusions
- Caveats with the analysis
- Does it make sense to invest in EPF?

We run a simulation using historical data to check which option has been better. The simulation takes the case of two individuals

Conservative investor Mr P who invests monthly in EPF
Risk-taking investor Mr S who invests the same in a (hypothetical) Sensex index fund

We are following the same methodology as our previous article on PPF vs mutual funds here: PPF vs. mutual funds: which is better?. The key difference between PPF and EPF is that while PPF is an optional investment open to all investors whether salaried or not, the EPF is open only to salaried employees but is mandatory for most salaried employees.

In this article, we will show the results of running a 15-year investment in EPF vs the Sensex (to represent stock investing via mutual funds) in this way:

we use historical interest rates and annual limits of EPF from 1952 till date, along with Sensex data from 1979
SENSEX data is the price index from 1979 to 1996 and then onwards it is the SENSEX Total Return Index (TRI) which includes dividends
we run a 15-year or 180-month simulation multiple times: from Mar-1979 to Mar-1994, Apr-1979 to Apr-1994 and so on. We chose 15 years since that is the maturity period for PPF in the original PPF vs. mutual funds analysis and have kept the same window for easy comparison
we do not exit the portfolios after 15 years, and hence there are no taxes on selling

We did not have mutual funds in 1979, but we have today, and not having mutual funds in the 1970s does not invalidate the conclusions below.

Historical interest rate of EPF

Using data from the EPF India website, we plot the historical interest rates of EPF since 1952.

EPF Interest Rate History

Some observations:

EPF rates before the 1980s were below the levels of today
will EPF rates go lower from the current levels: history shows us that it has been a lot lower, and there is no reason why it cannot go a lot lower
there was a long period of 15-ish years (1985 to 2000) where interest rates were their highest, i.e. 10-12%. If you have a longing for those rates, do remember the condition of the economy in the same period
EPF investment is capped at 12% of basic (plus DA) with an equal match from the employer per year
employees can invest more than this cap per year via the Voluntary Provident Fund (VPF) which has the same interest rate

SENSEX vs EPF yearly returns since 1979

Yearly SENSEX returns has been quite volatile but EPF, even with regular changes, the EPF rate has been quite stable.

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Making a monthly investment in stocks vs EPF

We will invest the same amount at the beginning of the month in EPF or Sensex. The amount is 1/12th of one lakh but since EPF is tied to salary (basic plus dearness allowance), we have assumed a hike of 10% of the investment amount per year. The interest rate taken is the actual EPF rate in that period. We also use the actual Sensex returns for the final portfolio value over the period.

15-year investment in EPF vs. mutual funds

Sensex vs EPF - 15 years of investing

The result shows that in most of the 300+ cases in this simulation, Mr S, the stock investor, comes out ahead. Only in some extreme market events, like the post-Harshad Mehta years, the 2008 global financial crisis or the 2020 COVID-19 crash, did the EPF portfolio do better in 13% cases.

Sensex vs EPF - XIRR of 15 years of investing

In this chart, we see how the returns of the EPF investment have risen and later fallen with EPF rates while that of the Sensex investment has been unpredictable.

Since EPF is a longer term investment, we will now compare EPF with mutual funds for 20,25 and 30 year holding periods with the same analysis methodology.

20-year investment in EPF vs. mutual funds

Sensex vs EPF - 20 years of investing

Sensex vs EPF - XIRR of 20 years of investing

25-year investment in EPF vs. mutual funds

Sensex vs EPF - 25 years of investing

Sensex vs EPF - XIRR of 25 years of investing

30-year investment in EPF vs. mutual funds

Sensex vs EPF - 30 years of investing

Sensex vs EPF - XIRR of 30 years of investing

The clear conclusion here is that for longer holding periods, investment in mutual funds has beaten EPF in all cases where data is available.

Conclusions

Caveats with the analysis

We should keep in mind the following points while concluding anything from this analysis:

the analysis uses ~45 years of data, but that does not mean that the trends seen in the past will repeat in the future
some active mutual funds with sufficient long history may have beaten the Sensex over most of these periods and hence do not change the conclusion
a “dumb” SIP in stocks is unpredictable, and returns vary considerably based on the ending point of the 15 years. Instead, the right way to follow goal-based investing and reduce equity allocation as the goal comes closer
we exclude the tax benefit under 80C for the EPF investment since it is straightforward to max out the ₹150,000 limit using other eligible investments

Can we use this data to say that “stocks are usually better than EPF”? That is mostly true. However, EPF has some benefits like guaranteed tax-free returns that stocks do not have.

There is another point that we need to keep in mind. From 2015 onwards, the EPFO is allowed to invest from 5-15% of its corpus (starting with fresh inflows) into the stock market via exchange traded funds. Therefore the fixed return of the EPF is somewhat contradictory given that the EPF portfolio now holds both bonds and stocks.

Does it make sense to invest in EPF?

We should not construct a portfolio for long-term goals only with stocks since we have shown before that the end result of such a portfolio is unknown. The better option is to create a portfolio with both debt and equity as asset classes and rebalance between the two per an appropriate glide path.

Given that the EPF is mandatory for salaried employees, it cannot be avoided. However, as per the results of this article, extra investments via the VPF for those who are salaried may be avoided. We will cover the alternative to EPF/VPF in a future article.

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