Personal Finance

How ELSS scores over PPF

Naveen Kukreja | Updated on January 20, 2019 Published on January 20, 2019

A comparison of the two tax-saving instruments eligible for Section 80C deductions

The onset of the tax-saving season has restarted the debate over ELSS vs PPF. Here is a comparison:

Risk vs returns

The Public Provident Fund is one of the safest tax-saving investment options. Being managed by the Centre, both the investment principal and the returns generated come with sovereign-backed guarantee. As equity-linked savings schemes primarily invest in equity shares, they are prone to inherent volatility of the equity markets. However, this risk can be mitigated by investing in ELSS through the SIP mode. Systematic investment plans help in cost-averaging during market corrections, and, thereby, help generate higher returns over the long term.

Contrary to popular perception, the interest rate on PPF do not remain fixed throughout the entire tenure. The Finance Ministry reviews interest rates of PPF along with other small savings schemes every quarter. The interest rates are set primarily on the basis of government bond yields. Currently, PPF pays 8 per cent p.a. on its investments, compounded annually. As its interest income and maturity proceeds are totally tax-free, its post-tax returns are among the highest among all fixed-income tax-saving instruments.

The returns generated by ELS schemes depend on the performance of their portfolio constituents. However, being an equity-oriented scheme, ELSS beats fixed-income instruments in the long term by a wide margin. For instance, ELSS as a category generated an average annualised return of about 10, 16 and 16.3 per cent over the last three-, five- and 10-year periods, respectively. Some of the top-performing ELSS funds such as Axis Long Term Equity Fund, ABSL Tax Relief 96 and Franklin India Tax Shield have delivered about 20, 19 and 16 per cent annualised returns, respectively, over the past five-year period.

To understand the gap, let’s assume that you invest ₹12,500 per month in your PPF account for 15 years. At an assumed rate of 8 per cent p.a., your corpus will grow to about ₹44.38 lakh after 15 years. However, if you invest the same in ELS fund(s) through SIP for 15 years, you will generate ₹63.07 lakh, assuming a conservative annualised return of 12 per cent.

Tax benefits

This is one area where PPF apparently beats ELSS. While the investment amount of both PPF and ELSS qualify for tax deduction under Section 80C, the interest earned from PPF is totally tax-free, whereas Budget 2018 brought ELSS gains under the tax net. Long-term capital gains (LTCG) exceeding ₹1 lakh in a financial year realised from equity and equity-related instruments like ELSS, equity MFs, etc, attract LTCG tax of 10 per cent.

The condition of ‘gains exceeding ₹1 lakh’, however, keeps most retail investors out of the LTCG ambit. Moreover, the higher upside potential of ELSS over the long term will also ensure that the post-tax return of well-performing ELS funds would continue to outperform tax-free PPF returns by a wide margin over the long term.

The biggest disadvantage of PPF lies in its relative lack of liquidity. It comes with a lock-in period of 15 years, and partial withdrawals can be made only from the seventh year of subscription, once a year. Premature closure is allowed only for pursuing higher education or treating life-threatening diseases after five years. While subscribers can get a loan against PPF deposits from the third to the fifth year, the loan amount, too, is capped at 25 per cent of the balance available two years prior to the loan application.

With a lock-in period of just three years, ELSS offers the highest liquidity among all Section 80C tax-saving options. While it is always advisable to stay invested in ELS schemes for the long term, having the option to redeem just after three years increases your financial flexibility.

PPF subscription requires a minimum investment of ₹500 per year during the entire subscription tenure. Failing to do so attracts a penalty of ₹50 per year apart from clearing the arrears subscription money of ₹500 per year. On the other hand, ELS schemes have no requirement of compulsory annual investment. Investors can also choose to stop their SIPs in an ELSS any time without attracting any penalty.

PPF was introduced in 1968 to encourage small savers to invest for their long-term goals and claim tax-deduction in the process. However, with better returns, higher liquidity and ease of investment, ELSS has established itself as an efficient investment tool for both tax-saving and realising long-term goals. Even conservative investors can reduce the market risk to their ELSS portfolio by switching their corpus to low-risk short-term debt funds in a staggered manner.

While picking your ELS schemes, compare the performances of various ELSS funds over the last three- and five-year periods with their benchmark indices. While past performances do not guarantee future ones, comparing funds will help you find out how various ELS funds have managed rising and falling markets in the past.

The writer is CEO and co-founder,

Published on January 20, 2019
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