For a long time whenever you thought of income tax saving options under Section 80C, the only idea that came to you mind was Public Provident Fund (PPF) and a handful of other products like Kisan Vikas Patra (KVP) and LIC policies. Most employees in the organized sector are familiar with the concept of Employee Provident Fund (EPF), wherein the individual and the employer contribute 12% of the basic salary each. This contribution is also eligible for deductions under Section 80C. However, EPF is more mandatory and hence is not the subject of discussion here. When we talk of provident fund in this context we are referring to the Public Provident Fund (PPF) that can be opened at any of your nearest post offices.
Two popular products for voluntary savings are PPF and ELSS. While PPF is a debt product issued by the post office, the ELSS is a tax-saving equity mutual fund issued by registered AMCs in India. The core difference between PPF and ELSS is that while PPF is a debt product, the ELSS is an equity product. Hence their risk profile vastly differs. However an ELSS versus PPF comparison must incorporate a number of considerations like returns, risk, liquidity, long term wealth creation etc.
Risk versus returns (ELSS versus PPF comparison)..
Purely based on the risk matrix, the PPF is much more safe and secure compared to the ELSS. PPF is backed by the government of India and hence is virtually free of default. However, there is the risk of the lock-in of 15 years in PPF and the minimum withdrawal lock-in of 7 years. During this period if the interest rates in the market go up then you are stuck at lower rates in PPF and that has an opportunity cost. Currently, PPF pays 7.9% compounded annually while there are no fixed returns in ELSS as it is an equity driven product. However, over longer periods of 8-10 years, the ELSS on average tends to yield around 14-15% annualized, which is a huge improvement over what you can earn on a PPF.
Liquidity considerations (Difference between PPF and ELSS)
ELSS has a lock in of just 3 years. At the end of 3 years you may choose to withdraw the entire amount and reinvest the proceeds in an ELSS and claim the benefits under Section 80C every third year. PPF is a 15-year lock-in product. Of course, there are intermittent liquidity facilities available. For example, withdrawals from PPF are permitted after the completion of 7 years. Similarly, after 3 years, the PPF allows you take a loan against your investment. Actually PPF scores here. While you can get funding up to 90% of the PPF balance in your account, your funding against ELSS will be limited to just 50% considering the volatile nature of equities. Of course, this haircut will be applicable on the market value.
Long term wealth creation: That is where ELSS scores over PPF..
The ELSS versus PPF comparison needs to be understood in the context of long term wealth creation. The biggest risk that investors are taking on today is “Not taking any risk”. Debt yields are falling consistently and the PPF returns are also likely to fall in tune with that. Of course, PPF returns will also be revised upwards with rise in interest rates but that is a remote possibility with inflation at such low levels. The power of compounding works perfectly in case of ELSS. In case of PPF, with 7.6% annual yield your long term wealth creation is severely restricted.
The ELSS scores on 2 fronts. Unlike PPF, where the outer limit for annual investment is Rs.150,000/-, there are no such limits for ELSS. Of course, you may not get tax benefits but then you still create wealth. Secondly, ELSS funds tend to outperform the normal equity funds as the 3-year lock in facilitates a more long term approach among fund managers. Also, ELSS managers can afford to maintain lower levels of liquidity. If you are looking at making the power of wealth creation work in your favour, then ELSS could be the answer for you!
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