PPF Vs ELSS: The battle of unequals

Public Provident Fund (PPF) and Equity Linked Savings Schemes (ELSS) are amongst the popular investment options for tax saving. While PPF invests in government bonds, ELSS invests in equities, so the former is almost risk-free (unless the government defaults) while the latter is a market linked investment.  Let’s look at both these options in detail.

PPF

PPF is a  central government backed debt instrument which offers fixed returns*. In this option both the principal investment (up to Rs. 1.5 Lakhs under section 80C) and maturity amount are completely tax exempt making it a safe investment avenue.

* interest rate revision linked to average G-sec yield

PPF Rates

PPF and Inflation

Any investment is typically looked at from returns or tax perspective, but it is also prudent to factor in inflation and evaluate the real returns.

The chart below shows the PPF rates against the average rate of inflation. Starting 2009 and up until 2013, the inflation percentage hovered around double digits in effect making the real return from PPF negative for those 5 years.

Source: CPI Average Inflation from Inflation.edu

This shows just how important a factor inflation is and why the decision to pick an investment option should consider the inflation expectation. For example, if you invest in a PPF for your child’s higher education while the inflation expectation as regards education costs is 8% then it is clearly not a wise choice.

ELSS

Equity Linked Savings Schemes are investments made in diversified equity mutual funds with a compulsory lock-in of 3 years. It is one of the most popular products for tax saving as it offers benefits with a lower lock-in period compared to other products in the segment.

PPF Vs. ELSS

The comparison between these two products is a bit like comparing apples to orange considering one is risk-free, and the other is market linked. However, it is fruitful to see how they peg against each other.

^ Only for medical emergency or higher education with 1% premature penalty

Comparison of historical returns

If Rs. 1 Lakh were invested in BSE Sensex in 2001 the amount would now grow to Rs. 6,71,379 implying a return of 13% while the same amount in a PPF investment would return Rs. 3,49,841 implying a return of 8.41%.

My View

Any investment decision should consider the risk profile of the investor and time horizon of the investment.  While comparing two different products may serve a theoretical purpose, but as an investor, if you don’t have the risk appetite to invest in a market-linked instrument, then the comparison if of little use to you.  My objective in this article is hence to give you a perspective and help you understand that these two investments have varied risk and return profiles. Given below are a few scenarios to throw some more light on the PPF vs. ELSS debate.

1. If you already have an existing equity or equity mutual fund portfolio tagged to your goals then, the Asset Allocation strategy should be followed with the aim to achieve your target return. PPF scores high as a part of your core debt portfolio while ELSS offers exposure to equity with a lower lock in period.
2. If you DO NOT have any equity or equity mutual fund in your portfolio, then for tax benefit purpose it would be prudent to start with ELSS. I would also advise you to understand the basics of inflation and power of compounding to make the most of your investment, because truth be told, investing for only the lock-in period of 3 years and then withdrawing may not yield the desired result.
3. If you are below 30 and a first-time investor, then ELSS offers the ideal route. The propensity to take risks goes down with age and other commitments, hence this sweet spot should be used for building long-term wealth.
4. Conversely, if you are someone nearing retirement, then it would be advisable to have a conservative portfolio and ELSS should be added if and only if your remaining portfolio is skewed towards debt or non-equity products.

Image Courtesy : Wikipedia / Wikimedia