ELSS vs PPF ¡ª Comparing Two Tax Saving, Wealth Creation Options

When it comes to fulfilling the dual purpose of tax saving and wealth creation, two popular investment instruments that come across our minds are- ELSS and PPF. And the debate surrounding ELSS vs PPF options under Section 80C of the Income Tax Act often leaves many potential as well as existing investors confused regarding which one to opt for and why.

To help you make an optimum choice through an informed decision, let us understand what ELSS and PPF are and how these two weigh against each other.

What is ELSS?

Equity-Linked Savings Schemes (ELSS) are tax saving equity oriented mutual funds that invest a majority portion of their portfolio into equity or equity related instruments. Being equity oriented funds, ELSS come with the same market risk as other equity funds. But their returns usually outperform not just inflation but also the various fixed income investment options under section 80C, as well as other asset classes, by a wide margin over the long-term.

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What is PPF?

Introduced in 1968 and revised in 2019 by the National Savings Institute of the Ministry of Finance under the Central Government, PPF (Public Provident Fund) is an investment cum tax saving scheme aimed to promote small saving schemes in India. PPF is preferred as one of the safest savings schemes in India, with both its principal and interest being fully backed by the Government of India through sovereign guarantee.

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ELSS vs PPF

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1. Risk

PPF stands amongst the safest tax-saving investment options available for investors. Managed by the Government of India, both the principal and the interest components come with sovereign-backed guarantee. As ELSS funds invest your money primarily in equities, they are prone to be exposed to the volatility of equity markets. However, this risk can be mitigated by choosing the SIP route for investing in ELSS. SIPs ensure regular investments at periodical intervals, which help in cost averaging during market corrections and thereby, help generate higher returns over the long term.

2. Returns

Contrary to the popular perception, the interest rates of PPF do not remain fixed throughout the entire tenure. The Finance Ministry quarterly reviews PPF interest rates along with other small saving schemes. Primarily, PPF¡¯s interest rates are set on the basis of government bond yields. Currently, PPF pays 7.1% p.a. on its investments, compounded annually. Given that both PPF¡¯s maturity proceeds as well as interest income do not attract any tax, PPF¡¯s post-tax returns tend to be one of the highest amongst various fixed-income tax-saving investments.

On the other hand, ELSS returns depend on their portfolio constituents¡¯ performance. However, the benefit of being an equity-oriented scheme assists ELSS to beat all fixed income instruments in the long term by a wide margin. For instance, ELSS as a category currently generates annualized average returns of 16.87%, 15.91% and 14.35% p.a. over the last 3-year, 5-year and 7-year periods respectively. (as per valueresearch data dated 14.09.2021)

3. Tax Benefits

This is one area where PPF apparently tends to beat ELSS. While the investment amount of both PPF and ELSS qualify for tax deduction under Section 80C, the interest earned from PPF is completely tax free, whereas the long term capital gains (LTCG) exceeding Rs 1 lakh in a financial year realized from equity and equity related instruments like ELSS, equity mutual funds, etc attract LTCG tax of 10%. However, the higher return potential fo ELSS over the long term tends to ensure that the post-tax returns of well-performing ELSS funds are capable of beating the tax-free returns of PPF, by a wide margin in the long run.

4. Liquidity

When compared to ELSS and almost all other investment avenues, the biggest disadvantage of PPF lies in its lack of liquidity due to a long lock-in period of 15 years. However, it allows the facilities of partial withdrawals and premature closure. Partial withdrawals are allowed only once in a year starting from the 7th year of subscription whereas premature closure is permitted after 5 years for treating life-threatening diseases of account holder, spouse, dependent children or parents or for funding higher education of account holder or his dependant children and in case of change in his residential status. While investors can avail loan against PPF deposits from the 3rd year to 5th year, the loan amount too has been capped at 25% of the balance available at 2 years prior to the loan application year.

On the other hand, with a much shorter lock-in period of just 3 years, ELSS offers the one of the highest degree of liquidity amongst all tax saving investment options under Section 80C. While it is advisable to remain invested in ELSS for the long term to maximize the return potential of equities, possessing the option to redeem the investment after 3 years raises the investor¡¯s financial degree of flexibility.

5. Compulsory minimum annual investment

Subscribing to PPF requires a minimum investment of just Rs 500 per year during the entire tenure subscribed for. Failure to deposit this amount can attract a penalty of Rs 50 per year, besides having to clear the arrear annual subscription money of Rs 500. ELSS schemes, on the other hand, usually do not put forth such a requirement of compulsory investments, and even give investors the flexibility to choose to stop/pause their SIPs without having to incur any penalty.

Making the decision - Which one to choose?

PPF primarily focuses on the aim to encourage small savers to invest for their long-term financial goals and simultaneously claim tax-deduction in the process. When compared to ELSS funds¡¯ category average returns of 16.87% and 15.91% p.a. over the past 3 and 5 year periods respectively (as per valueresearch data dated 14.09.2021), PPF¡¯s current interest offering of 7.1% p.a. (for the quarter July-Sept 2021) as well as the range of close to 7-8% p.a. interest rate offered since the past two decades, fall behind the returns of ELSS by a wide margin. Thus, with higher returns, greater degree of liquidity and higher level of ease of investment, ELSS certainly holds an upper hand over PPF and almost all tax saving instruments offering the twin benefits of tax-saving as well as wealth creation.

While selecting your ELSS funds, always ensure to compare the performances of various ELSS funds over the past periods with their peers and benchmark indices. While past performances do not guarantee future returns, such comparison assists in knowing how the funds have dealt, managed and performed during previous market as well as economic cycles.

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