Do ELSS funds give better returns than PPF?

The debate of ELSS versus PPF got a new twist after the Budget 2018 imposed 10% tax on long term capital gains on equity funds at the time of redemption.

Apr 07, 2019 09:04 IST India Infoline News Service

Equity Linked Savings Scheme
To begin with Public Provident Fund (PPF) and Equity Linked Savings Scheme (ELSS) are not strictly comparable as asset classes. PPF is a debt product giving an assured return through the life of the PPF. In addition, there is also the tax benefit under Section 80C of the Income Tax Act up to an outer limit of Rs1.50 lakhs on PPF. On the other hand, the Equity Linked Savings Scheme (ELSS) is a pure equity mutual fund scheme, and hence, carries market risk (both systematic and unsystematic). However, the lock in period is much lower at just three years, compared to 15 years in case of PPF. ELSS is also instrumental in wealth creation since diversified equity funds tend to outperform other asset classes over a long period of time.
 
The debate of ELSS versus PPF got a new twist after the Budget 2018 imposed 10% tax on long term capital gains on equity funds at the time of redemption. Of course, the Income Tax Act allowed a basic exemption of Rs1 lakh per year although the benefit of indexation was taken away. Having understood the different risk profile of ELSS and PPF, does the tax on LTCG really dent the returns of ELSS versus the PPF?
 
ELSS versus PPF – What gives better returns in post-tax terms?
We are making a comparison of a PPF product and a diversified ELSS fund over a period of 15 years (which is lock-in for PPF). Let us see how they compare in post-tax terms.
PPF Details ELSS Details
Amount Invested 50,000 Amount Invested 50,000
Section 80C Rebate 30% Section 80C Rebate 30%
Holding Period (Years) 15 Holding Period (Years) 15
Actual Rebate 15,000 Actual Rebate 15,000
Effective Investment 35,000 Effective Investment 35,000
Annual Yield 8% Annual Yield 14%
Final Sum 1,58,608 Final Sum 3,56,897
Basic Exemption       -   Basic Exemption 1,00,000
Tax Rate (0%) -   LTCG Tax (10%) 20,690
Post Tax Sum 1,58,608 Post Tax Sum 3,36,207
Post Tax CAGR (%) 10.59% Post Tax CAGR (%) 16.28%
 
In the above example, we have factored in the impact of the tax shields of Section 80C and also the tax on LTCG payable on ELSS funds. We have considered the investor to be in the 30% peak income tax bracket but we have ignored surcharge and cess for the sake of simplicity. The tax exemption has been adjusted against the initial investment and a lower base has been considered for calculating the final Post Tax CAGR returns. Here is what you can find.
 
The ELSS has a better advantage over a 15-year period as time and the power of compounding really works in favour of ELSS. Also, the impact of the LTCG tax on the post-tax CAGR gap between ELSS and PPF is not much. Of course, PPF does have the prima facie advantage of being totally tax free at the time of redemption. However, the impact of the LTCG tax on ELSS returns is not significant.
 
ELSS vs. PPF for tax saving: How to make a choice?

With an outer limit of Rs1.50 lakhs for Section 80C, all these products end up competing with each other. Here are five parameters to make a choice.
  • If you are young and just starting off on your career, then prefer ELSS over PPF. It is a better creator of long term wealth.
  • For those who are having lower risk appetite, PPF may be a better choice as the product is government backed. Even in this case, ELSS works better over longer time frames.
  • ELSS is equity and PPF is debt. Both these products must, therefore, fit into the overall allocation to equity and debt in your financial plan.
  • When it comes to ELSS, it is best to opt for a systematic plan. It not only synchronizes with your inflows but also gives the power of rupee cost averaging.
  • ELSS has the lowest lock-in period among all the Section 80C investments of just 3 years. That makes ELSS a much better source of tax benefit maximization. That must be factored into your calculations.

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