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Battle of Tax-Savers: ELSS vs PPF

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We continue from Part 1 of this “Battle of Tax-Savers” series where we compared ELSS funds with tax-saving FDs. Click here to read that article where we also introduce the basics of 80(C) tax savings. In this article, we will compare ELSS funds against arguably the most popular tax-saving scheme — Public Provident Fund or PPF. You might like to know that ₹1.5 lakh invested annually in an ELSS fund (ABSL 96 Tax Relief) for last 22 years has given ₹4.84 crores higher returns than same investment in PPF! Can’t believe what you just read? Read on to find out more.

What is PPF?

Public Provident Fund, or PPF is a small savings scheme offered by banks. Investments made in PPF have a lock-in of 15 years and give a fixed return according to the interest rate published by the Ministry of Finance every quarter. The interest rate on PPF stands at 7.60% for Q4 FY17–18 as per the latest govt. notification. Investment in PPF is tax-exempt subject to ₹1.5 lakh total exemptions across various 80(C) schemes. The interest earned on PPF is also tax-exempt.

What are ELSS Funds?

ELSS mutual funds are a special category of mutual funds that offers tax exemption under section 80C. These funds invest a majority of the corpus in equity or equity-linked products and thus offers higher returns than other 80C instruments. They carry a 3 years lock-in period. Investment in ELSS are tax-exempt up to ₹1.50 limit across various 80(C) investments. Returns from ELSS funds are tax-free as well.

Point-to-point Comparison of ELSS and PPF

*Tax exemption across both PPF and ELSS investments are subject to an overall ₹1.50 lakh deduction limit across various 80(C) schemes.

Returns Comparison

Returns in PPF are guaranteed by the government thereby making it nearly free from market risks. While there is no volatility (fluctuation) in the returns guaranteed, there is still a risk of PPF returns not beating inflation. Also, the government has been steadily decreasing the PPF interest rate. The PPF interest rate used to be 12% at the beginning of this century, now stands at a modest 7.60%. A high rate of inflation could erode the value of savings in PPF.

On the other hand, returns from ELSS are market-linked and there are no assured returns. Yet, historically average ELSS funds have generated healthy returns of ~15% over the long-term while the good ones have given 20%! One can expect 12–15% returns from ELSS if remaining invested for 7–10 years. Let us see 2 case studies to illustrate this.

Illustration 1: Assume Rohit invested ₹1,50,000 in PPF while his friend Rashmi invested ₹1,50,000 in an ELSS mutual fund. Both remain invested for 15 years and then withdraw their investments. Consider the returns in the following table for both the cases:

* ELSS funds expected to return 13% over 15 years, current rate taken for PPF; **both ELSS and PPF returns are tax-free; Mutual fund Calculator is available here

As you can see, Rashmi generated more than 2.5 times the returns with ELSS funds as compared to Rohit with PPF!

Illustration 2: As you can also see in this image below, how 1.5 lakh invested annually in ABSL 96 Tax Relief ELSS fund for last 20 years compares with the same investment done in PPF. While ELSS investment grew to a massive ₹5.67 crores, PPF investment just grew to a mere ₹86 lakh!

Conclusion

As we can see from above, both PPF and ELSS allow similar tax-exemption on investment and returns. While the conventional choice of PPF gives guaranteed returns, ELSS mutual funds have generated much higher returns. With low-yet-guaranteed returns, PPF is suitable to a small set of extremely risk-averse or conservative individuals. Lower lock-in period (3 vs 15) and higher expected returns (12–15% vs 7.6%) clearly make ELSS the better choice to PPF for most investors. That said, investment in ELSS mutual funds should be ideally done through a monthly SIP (Systematic Investment Plan) to reduce market risk and increase the chances of a higher return. Investments in ELSS should be done with a long-term view of 5–10 years so that the dual benefits of compounding and capital appreciation can be reaped in.

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