There seems to be a lot of confusion when it comes to the PPF and ELSS. To the point that individuals make (absolutely wrong) comparisons between both. Without much ado, let me tell you why this is so wrong.
Their structure is completely different
One is a fixed return investment, the other is a market-linked investment where the potential for return is higher, but not guaranteed.
The Equity Linked Savings Scheme (ELSS) is a diversified equity mutual fund that invests in 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. Please read Should I exit my ELSS after 3 years?
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 cite just two examples.
You are assured of a fixed return, though the exact figure fluctuates. The rates are fixed every quarter and benchmarked against the 10-year government bond yield. This periodic exercise is to keep it aligned with the current interest rate scenario.
- Interest rate is compounded annually
- Interest is calculated on a monthly basis
- Interest is paid on the lowest amount between the fifth of the month and the last day of the month
- Interest is credited to the account at the end of the financial year, March 31
- Interest rate is reset every quarter. It is currently 7.1% per annum.
Tax benefit under Section 80C
This is the only similarity. They both offer a tax break 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 a single financial year. In the case of PPF, the maximum investment limit is Rs 1.50 lakh every financial year. The financial year spans from April 1 to March 31. Please read Do NOT make these 5 tax-planning mistakes.
Lock-in period
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.
The PPF is a 15-year investment with a 16-year lock-in. The first year is not taken into consideration when looking at the maturity of the account. The end of the financial year in which the deposit was made is what matters. So, if you opened the account on July 15, 2000, the 15-year tenure will commence from the end of FY2000-01 (March 31, 2001). That means it would have matured on March 31, 2016. Please read 6 questions that tell you everything about PPF.
Taxation
PPF really scores on this front. The interest earned is tax free, and the amount accumulated on maturity is exempt from tax.
When it comes to 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. Please see our analysis in 5 ELSS rated by our analysts.
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.
The PPF could be part of your overall debt allocation.
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.
Please read Tax Planning is NOT separate from Financial Planning
