ELSS VS PPF: Which is better

Public Provident Fund (PPF) is  one of the best tax saving investments for risk-averse investors. PPF offers the triple benefits of tax saving, risk free returns and tax free returns. As per the provisions of the new Union Budget, investors can deposit up to Rs 1.5 lakhs per annum in their PPF account, resulting in an annual tax saving of up to Rs 47,000/- for investors in the highest tax bracket. The PPF interest rate for the current year is appx 7%.Government has linked this to bond yields which is the need of the hour as per global economy so the proceeds may  may decline or increase as per the bond yield. Reason for this is that the 10 yr govt. bond yield is at all time high at 6%. Interest rates are already softened and hence the bond yield impact on  the PPF rates as well.

PPF Returns:
The return in PPF has declined over the years. From 12% at the turn of the century, it dropped down to 11%, then 9.5%, 9% and finally 7% where is languished for many years. Between FY12 and FY18 the rate hovered around 8-8.5%

ELSS as a tax saving Investment
Comparison of PPF and ELSS Investments 

ELSS vs Public Provident Fund (PPF)
	ELSS	PPF
Lock-in Period	3 Years	15 Years
Investment Limit	No Limit	Rs. 150,000 per year
Maximum Investment for Deduction under 80C	Rs.150,000	Rs.150,000
Minimum Investment	Rs.500	Rs.500
Returns	Based on performance of equity markets	Rates are fixed by the Central government (currently 8.7%)
Risk	Medium to High	Low

Should you invest in PPF or ELSS

• Investors with high risk tolerance should invest in ELSS, while investors with low risk tolerance should invest in PPF. Over a long time frame wealth creation potential is much higher with ELSS, as we saw in the charts above.

• Young investors should opt for ELSS, since they usually have high risk tolerance and a sufficiently long time horizon to ride out the volatility associated with equity investments.

• If you do not have a PPF account and you are 15 or 20 years away from retirement, you should open a PPF account and start making regular deposits, so that you can accumulate a corpus by the time you retire. As you approach retirement, your risk tolerance goes down and PPF is a better investment option in such a situation.

• Investors with moderate risk tolerance level can invest in both PPF and ELSS in accordance with their optimal asset allocation strategy. You can read about some general asset allocation guidelines in our article, Asset Allocation strategies for different age groups.

• Salaried individuals are mandatory required to contribute a portion of their salary to employee provident fund (EPF). The EPF interest rate is similar (slightly lower) to the PPF interest rate and the maturity amount is tax free. The EPF contribution of the employee goes towards the 80C tax savings. Therefore they should opt for ELSS, unless they are near retirement. Investment in ELSS through systematic investment plans (SIPs) over a long time horizon will help you both in tax planning and retirement planning.

• Self employed individuals should make regular PPF deposits for their retirement planning. It is a good idea to extend your PPF even beyond maturity in blocks of 5 years, if you do not need the liquidity immediately. You can continue to make deposits to your PPF. Even if you cannot make deposits every year, you can stay invested in PPF and your accrued balance will continue to earn tax free interest.

• Investment horizon is another important consideration, in deciding between PPF and ELSS. The tenure of PPF is 15 years with very limited liquidity during the term of the investment. If you have an investment horizon of 5 to 10 years for any specific financial objective, then you cannot rely on PPF. ELSS may be a good investment choice for a 5 to 10 year time horizon, provided it is suitable for your risk profile.

Liquidity Considerations

• The tenure of PPF is 15 years and is extendable in blocks of 5 years. While liquidity of PPF is lower than other tax saving fixed income investments, PPF does offer limited liquidity options through withdrawals and loans, during the term of the investment. Withdrawals not exceeding 50% of fourth year balance or 50% of the balance at the end of the immediate preceding year, whichever is lower, are permitted after a lock-in period of 7 years. PPF also offers loan facilities from third year onwards under special circumstances. The loans can be availed between third and sixth year, and should not exceed 25% of the balance second immediate preceding year. Rate of interest of the loan will be 2% more than prevailing PPF rate and the loan must be repaid in two years. The withdrawal and loan facilities notwithstanding, PPF is essentially a very long term investment. Investors must be prepared to wait for at least 15 years to get the maturity amount.

• ELSS has a lock-in period of three years from the date of the investment. In other words, investors will not be able to redeem their units for the first three years. If you invest in an ELSS through a systematic investment plan (SIP), each SIP investment will be locked in for three years from their respective investment dates. You can opt for both growth and dividend options. But you should not opt for dividend re-investment option, because the every dividend re-invested gets locked in for 3 years in an ELSS. So a portion of your dividend gets locked-in for ever. If you have opted for dividend re-investment in an ELSS fund, you can switch to the dividend payout option. Some mutual funds also allow investors to switch from dividend re-investment to growth option.

For investors with risk appetite, Equity Linked Saving Schemes (ELSS) is one of the most popular investments allowed under Section 80C. Investors can avail triple benefits of tax savings, capital appreciation and tax free returns in ELSS. An ELSS is essentially a diversified equity fund with a lock in period of three years from the date of the investment. From a tax-ability of returns perspective, both capital gains and dividends from ELSS are tax free. Over a long time horizon equities give much higher returns compared to other asset classes. However, since ELSS funds are market linked investments, they are subject to market risk and volatilities. Historically, good ELSS funds have given excellent returns. In the last ten years ELSS funds on average have given more than 19% trailing annualized returns. The chart below shows average historical returns of the ELSS funds category.   

In the strict sense, it is not fair to compare PPF and ELSS. PPF is a risk free investment, whereas as ELSS is subject to market risks. For the sake of illustration we have shown the comparison of returns of Rs 50,000 annual investment in PPF and a good ELSS fund, over a long investment.

If you started an Rs 12,500 Monthly PPF deposit in 2011, your PPF corpus as on Apr1 2021 will be Rs 23.5 lacs, See the difference below

If you had started an Rs 150,000 annual investment in a top ELSS fund from 2010, see the difference. I have not taken for 15 years as Axis started its operations in end of 2009. Now you can imagine for 15 years

In Finance if we apply a rule of 72.. and even  considering avg return of 16% from ELSS and 9% from PPF then your investment is doubling every 4.5 years in ELSS and 8.5 years in PPF. 

Now conservative people have always doubt in mind that stock markets fall badly. Above data contains the 2 biggest falls in Indian stock market history i.e. of 2008 and 2011, even in 2015 stock indices were -ve.


Both PPF and ELSS have their merits and demerits. Your investment choice should be informed by your investment objectives and your risk tolerance level. Your risk tolerance level is based on several factors (discussed in our article Measuring Risk Tolerance of Investors). Age and financial situation are certainly two important factors that determine risk tolerance of an investor.

Conclusion

Both PPF and ELSS are wonderful tax saving investment options. However, their suitability depends on the financial objectives and the risk profiles of the individual investors. Investors should consult with financial planners or advisors to understand their individual risk profiles, and the most suitable tax saving investment options.

References:

1.  An article/Data from Sh Dwaipayan Bose on a mutual fund advisory site.

2. Data from https://stableinvestor.com/

3. Data from Advisory site

Disclaimer: The views echoed above are presented on the basis of available data. Investors should do their own analysis or take help of an advisory services before investing in any of the above depending upon their needs and risk adverseness. There are other avenues of tax saving in 80 C which are not discussed here, folks can refer to my other articles for the same..