Why you can't compare PPF with ELSS

A reader asked us which is more preferable, PPF or ELSS.

The Equity Linked Savings Scheme (ELSS) is a mutual fund that invests in stocks.

The Public Provident Fund (PPF) is a fixed return investment backed by the government. Money collected from all small saving schemes, including PPF, are deposited in the National Small Savings Fund (NSSF), from where it is invested in central and state government securities, which fund large public sector institutions like the Food Corporation of India and National Highways Authority of India, to give an example.

• PPF: Tax benefit under Section 80C
• ELSS: Tax benefit under Section 80C

In this they are similar. 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 a single financial year. In the case of PPF, the maximum investment 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

An ELSS is open-ended fund enabling investors to 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 March 1, 2020, the lock-in period will be 3 years starting from March 2020. For the instalment made on December 1, 2018, the lock-in period will commence for 3 years from December 2018.

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

The PPF is a fixed-return investment that is backed by the government. The current rate of interest is 7.1% per annum (compounded annually).

An ELSS is a diversified equity mutual fund. Which implies that the underlying portfolio is stocks. Unlike a thematic fund (infrastructure, financial services) or a sector fund (auto, 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 tilt focus (large-cap, mid-cap, small-cap).

Being a market-linked product, there cannot be any guarantee or assured returns. So time your exit accordingly. 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. As with any equity investment, exit when the market is better positioned. Hence, even though it has a 3-year lock-in, keep a long-term perspective in mind.

• 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.

Making the choice

As is evident, the two are not the same and are part of different asset classes; equity and debt. Deciding which one to invest in must be viewed in conjunction with your goals and overall portfolio. I tackled this in Do you really need a PPF account?

If you opt for an ELSS, do remember that the funds are not uniform. Yes, they are all diversified equity funds and all offer a break under Section 80C. They will differ in their market-cap tilt, concentration of portfolio, cash calls, sector exposure, growth or value style, and so on. 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. And please do not make the mistake of just picking up the best performer over the last year.

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