When it comes to tax saving, one of the major dilemmas that most of us face is whether to invest in the Public Provident Fund (PPF) or in Equity-Linked Savings Scheme (ELSS) mutual fund. While the former is a debt asset generating returns with low volatility over the long term, the latter is a market-linked equity investment exposed to the vagaries of the stock market.

While both PPF and ELSS are a part of the bouquet of investments included in the Section 80C of the Income Tax Act, wherein a maximum of Rs 1.5 lakh can be invested to reduce the tax liability as per one’s income slab, instead of making a choice between the two, can one consider investing in both of them in building up a corpus for the long term? Let us find out.

Why comparison is futile

The returns generated by PPF or ELSS should never be compared – it will be akin to comparing orange to apple because as the underlying securities in both asset classes are inherently different, the return generated will also be different.

Comparing them is not warranted as both PPF and ELSS belongs to different asset classes, with one currently generating around 8 per cent return as compared to the other generating around 12 per cent (historical returns) return. Importantly, PPF carries a fixed rate of interest, while ELSS returns are based on stock market performance.

Illustratively, Out of the Rs 1.5 lakh Section 80C limit, if Rs 75,000 is invested in PPF for 15 years at an assumed growth rate of 7.8 percent it will yield approximately Rs 21.61 lakh, while an equal amount in ELSS assuming a growth rate of 10.8 percent over the same period will yield about Rs 28.13 lakh, close to Rs 50 lakh through tax saving investments with half the risk involved!

Why diversify between the two

Diversifying one’s savings in PPF and ELSS would serve the purpose rather than relying entirely on any one of them. Irrespective of varying interest rate cycles and markets seeing the lows and new highs over the previous decades, PPF remains an investment that cannot be shied away even by the millennials. PPF continues to benefit even the old-timers and may continue to benefit even the youngsters.

Equities are supposed to be volatile and one of the ways to reduce its volatility is to hold them for a longer duration. ELSS investors will have to understand this and take it in their stride that the returns may or may not be adequate once the lock-in ends after three years.

The PPF’s forte

Few factors that make PPF a popular choice among long time investors are – Firstly, the interest earned in PPF is tax-free under Section 10 and does not add to one’s tax liability, and Secondly, the interest gets the benefit of annual compounding in PPF. This is how it works – Interest declared by the government gets added to the investment and then interest in future years interest is declared on the previous year balance. Simply put, in compounding interest is paid on interest, the impact of which is huge especially in the later years. Thirdly, the investment made and the earned enjoys the sovereign guarantee.

On maturity of PPF and ELSS

Even after the maturity of the PPF account, one can continue with it as the PPF account can be extended indefinitely in a block of five years, with or without making fresh contributions. Understandably, there will be a need for regular income and therefore PPF allows partial withdrawals even during the extended period.

In the case of ELSS, once the three-year lock-in period ends, one may continue the scheme with no further lock-in. Studies done in the past have shown that equities have generated high inflation-adjusted return than other asset classes over the long term.

Conclusion

Estimate the amount of savings you need to do for tax saving. Based on your risk profile, you may divide the amount between the two. Your investments in PPF will reflect steady growth in the savings while the ELSS investments will take care of the inflation-adjusted goals through the equity exposure over the long term.