ELSS or PPF? A wrong comparison

By Larissa Fernand |  27-01-21 | 

We looked at PPF, NSC and FD as tax-saving investments. Which bring us to a question many investors ask: How does ELSS compare with PPF? A very wrong question.

For starters, there is no one-size-fits-all answer to that question. Both are completely different products. The PPF is the Public Provident Fund, while ELSS is an acronym for Equity Linked Savings Scheme.

Secondly, investors tend to assume that all investments that fall under Section 80C are similar and can be blindly compared – ELSS, PPF, NSC, 5-year bank deposits. Big mistake! PPF and ELSS are two are very different investments and cannot be compared. Here’s why:

  • PPF: Fixed-return investment.
  • ELSS: Market-linked investment.

An ELSS is a diversified equity mutual fund. Which implies that a minimum of 80% of the fund’s assets will be invested in the stock market. Unlike a thematic fund (infrastructure, financial services) or a sector fund (IT, FMCG, pharma), this is a diversified fund that will invest across sectors and industries. The fund manager also has the liberty to decide the market cap focus.

  • PPF: Investment gets a tax benefit under Section 80C.
  • ELSS: Investment gets a tax benefit under Section 80C.

Let’s say your total income is Rs 12 lakh. And you invest Rs 1.50 lakh under Section 80C. The total taxable income drops to Rs 10.50 lakh. Bear in mind that this limit of Rs 1.50 lakh also encompasses other investments and deductions.

There is no maximum investment limit to your investment in the ELSS, however, only amounts up to Rs 1.50 lakh are eligible for a tax break. In the case of PPF, the maximum limit is Rs 1.50 lakh every financial year (April 1 to March 31).

  • PPF: Lock-in period of 15 years.
  • ELSS: Lock-in period of 3 years.

The fund is open ended, which means you can buy and sell units anytime. But to avail of the tax benefit, the investment must be locked-in for a minimum of 36 months.

If you do a Systematic Investment Plan (SIP), it will be three years from the date of investment. Every instalment will have a 3-year lock-in commencing from the date of that specific instalment. After the lock-in period, you can access your money any time since it is an open-ended fund. So, for the SIP done on, say, March 1, 2018, the lock-in period will be 3 years starting from March. For the instalment made on December 1, 2018, the lock-in period will commence for 3 years from then.

  • PPF: The interest earned is tax free, the amount accumulated on maturity is exempt from tax.
  • ELSS: You pay LTCG when you sell the units.

Since these funds have to be held for at least three years, on redeeming the units, long-term capital gains (LTCG) comes into play. For a number of years, tax on LTCG on equity was nil. The Union Budget of 2018 reintroduced LTCG tax on equity. Investors will now have to pay 10% tax on gains exceeding Rs 1 lakh, made from the sale of equity or equity oriented mutual funds.

  • PPF: The returns are assured.
  • ELSS: The returns are not guaranteed.

The ELSS is a market-linked product, so there cannot be any guarantee or assured returns. As with any equity investment, exit when the market is better positioned. Just because you have completed the 3-year lock-in does not mean you HAVE to sell your units. You may have to wait for a while if the market is in the doldrums. Hence with every equity investment, keep a long-term perspective in mind.

The current PPF rate is 7.1% (January 1 – March 31, 2021). The rates are fixed every quarter.

Before you invest…

While we are not underplaying the importance of finding the right tax-saving investment, the heavy lifting of any financial plan starts well before investment selection. If your portfolio does have a very heavy equity exposure, then by all means consider PPF. On the other hand, if your equity exposure is much less than desired, look at ELSS.

ELSS does make for an excellent investment if you have a low allocation to equity. It has the potential for wealth creation and the likelihood of beating inflation; as interest rates fall, so will the return on fixed-income instruments. An exposure to equity is necessary for investors to meet their goals.

However, exercise caution. You need to choose your fund wisely as there are numerous options available in the market and not all good.

The funds could widely differ from each other. They are diversified equity funds. They fall under Section 80C. The broad similarity ends there. Some will have a mid-cap tilt, others will have a large-cap tilt, and still others will have a multi-cap tilt. One fund may take cash calls, another may not. One fund may opt for a concentrated portfolio, others may prefer an extremely diversified one. One fund manager may look at growth stocks, another may favour value. Pick the ELSS looking at your entire portfolio. The fund must blend with the other funds you own and not needlessly bulk up the portfolio.

Good tax management can go a long way towards enhancing your return, but the decision needs to be made in conjunction with your overall portfolio and not in an ad-hoc fashion.

Also read:

(Investment Always Involves Risk of Loss)
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