Important Differences Between ELSS and PPF

ELSS

ELSS stands for Equity Linked Saving Scheme. It is a type of mutual fund that primarily invests in equity and equity-related instruments. ELSS is specifically designed to provide tax benefits to investors under Section 80C of the Indian Income Tax Act, making it a popular tax-saving investment option in India.

Examples of ELSS

Here are a couple of examples to help illustrate how ELSS works:

Example 1: Lump Sum Investment

Suppose Mr. Patel decides to invest in ELSS through a lump sum investment. He invests Rs. 50,000 in an ELSS fund on January 1, 2023. The ELSS fund has a lock-in period of three years.

Over the next three years, the ELSS fund performs well, and Mr. Patel’s investment grows at an average annual return of 12%. After three years, on January 1, 2026, Mr. Patel decides to redeem his investment.

Calculating the investment growth:

Investment amount: Rs. 50,000

Average annual return: 12%

Investment duration: 3 years

After three years, the investment would have grown to:

Rs. 50,000 + (50,000 * 0.12 * 3) = Rs. 56,400

Mr. Patel can redeem the investment on January 1, 2026, after completing the lock-in period. He receives Rs. 56,400, which includes his initial investment of Rs. 50,000 and the growth of Rs. 6,400.

Example 2: Systematic Investment Plan (SIP)

Mrs. Sharma decides to invest in ELSS through a systematic investment plan (SIP). She invests Rs. 5,000 per month in an ELSS fund for a duration of three years. Each SIP installment is made on the 5th day of every month.

Over the three-year investment period, the ELSS fund generates an average annual return of 10%. Mrs. Sharma completes her SIP investment on the 5th day of the 36th month.

Calculating the investment growth:

Monthly SIP amount: Rs. 5,000

Investment duration: 3 years

Number of installments: 36

Average annual return: 10%

After three years, Mrs. Sharma’s total investment would amount to:

Rs. 5,000 * 36 = Rs. 1,80,000

Calculating the investment growth with an average annual return of 10%:

Investment growth = Rs. 1,80,000 * (1 + 0.10)^3 = Rs. 2,42,000

After completing the lock-in period, Mrs. Sharma’s investment grows to Rs. 2,42,000. She can choose to redeem the investment or continue to stay invested based on her financial goals and market conditions.

Objectives of ELSS

The primary objectives of Equity Linked Saving Scheme (ELSS) are as follows:

• Tax Savings:

ELSS is designed to provide tax benefits to investors. It aims to help individuals reduce their tax liability by offering tax deductions on the amount invested in ELSS under Section 80C of the Indian Income Tax Act. Currently, the maximum deduction allowed is Rs. 1.5 lakh per financial year.

• Long-Term Wealth Creation:

ELSS aims to generate long-term wealth appreciation for investors. By primarily investing in equity and equity-related instruments, ELSS seeks to provide capital appreciation over an extended investment horizon. It is a suitable investment option for individuals looking to create wealth over the long term.

• Equity Exposure:

ELSS provides investors with exposure to the equity market. By investing in a diversified portfolio of equities, ELSS enables investors to participate in the growth potential of companies across different sectors. This exposure to equities allows investors to benefit from the potential upside of the stock market.

• Diversification:

ELSS funds invest in a diversified portfolio of stocks across various sectors. This diversification helps mitigate the risk associated with investing in individual stocks or sectors. By spreading investments across different companies and industries, ELSS aims to reduce the impact of market volatility on the overall investment portfolio.

• Flexibility in Investment:

ELSS offers flexibility in investment options. Investors can choose to invest in ELSS through lump sum investments or systematic investment plans (SIPs). SIPs allow investors to invest a fixed amount at regular intervals, such as monthly or quarterly, thereby reducing the impact of market timing and benefiting from rupee cost averaging.

• Potential for Higher Returns:

ELSS investments have the potential to generate higher returns compared to traditional tax-saving investment options like fixed deposits or PPF. By investing in equities, which historically have provided higher returns over the long term, ELSS aims to offer the potential for capital appreciation and wealth creation.

Types of ELSS

There is typically one main type of Equity Linked Saving Scheme (ELSS) based on the investment style and strategy used by the fund manager.

Actively Managed ELSS Funds: These are the most common type of ELSS funds. In actively managed ELSS funds, the fund manager actively selects and manages the portfolio of stocks within the fund. The fund manager conducts research, analysis, and makes investment decisions based on their market outlook and investment strategy. They aim to outperform the benchmark index and generate higher returns for the investors. The portfolio holdings are periodically reviewed and adjusted based on market conditions and the fund manager’s assessment.

Apart from this primary distinction, ELSS funds can also offer different options to investors regarding dividend payouts:

• Dividend Option:

ELSS funds may provide a dividend option, where the fund periodically distributes dividends to investors from the profits earned by the fund. Dividends are declared by the fund based on the performance and availability of distributable surplus. Investors choosing this option receive regular dividend payouts, which they can utilize as per their requirements.

• Growth Option:

ELSS funds also offer a growth option, where the profits earned by the fund are reinvested back into the fund. In the growth option, investors do not receive regular dividend payouts. Instead, the returns are reflected in the increase in the Net Asset Value (NAV) of the fund. Investors can benefit from capital appreciation when they redeem their investment in the future.

PPF

Public Provident Fund (PPF) is a long-term investment and savings scheme initiated by the Government of India. It was established under the Public Provident Fund Act, 1968, and is administered by the Ministry of Finance. PPF is a popular investment avenue in India and offers attractive features and benefits to investors.

Examples of PPF

Here are couple of examples to help illustrate how the Public Provident Fund (PPF) works:

Example 1: Lump Sum Investment

Mr. Kumar decides to invest in PPF through a lump sum investment. He deposits Rs. 1,00,000 into his PPF account on April 1, 2023.

Over the next 15 years, the PPF interest rate remains constant at 7%. The interest is compounded annually and credited to Mr. Kumar’s account at the end of each financial year.

Calculating the maturity amount:

Principal investment amount: Rs. 1,00,000

Interest rate: 7%

Investment duration: 15 years

Using the compound interest formula:

Maturity amount = Principal amount * (1 + (interest rate / 100))^number of years

Maturity amount = Rs. 1,00,000 * (1 + (7 / 100))^15

Maturity amount = Rs. 1,00,000 * (1.07)^15

Maturity amount ≈ Rs. 3,38,635

After 15 years, on April 1, 2038, Mr. Kumar’s investment in PPF matures, and he can withdraw approximately Rs. 3,38,635.

Example 2: Annual Contributions

Mrs. Sharma decides to invest in PPF by making annual contributions. She deposits Rs. 50,000 into her PPF account at the beginning of each financial year for 15 years.

Assuming a constant interest rate of 8% over the investment period, the interest is compounded annually and credited to Mrs. Sharma’s account at the end of each financial year.

Calculating the maturity amount:

Annual contribution: Rs. 50,000

Interest rate: 8%

Investment duration: 15 years

Using the compound interest formula:

Maturity amount = Annual contribution * [(1 + (interest rate / 100))^number of years – 1] / (interest rate / 100)

Maturity amount = Rs. 50,000 * [(1 + (8 / 100))^15 – 1] / (8 / 100)

Maturity amount ≈ Rs. 18,68,038

After 15 years, Mrs. Sharma’s investment in PPF matures, and she can withdraw approximately Rs. 18,68,038.

Objectives of PPF

The Public Provident Fund (PPF) has the following objectives:

• Long-term Savings:

The primary objective of PPF is to encourage long-term savings among individuals. It provides a disciplined savings avenue for individuals to accumulate funds over an extended period, typically for retirement planning or meeting long-term financial goals.

• Financial Security:

PPF aims to promote financial security by providing individuals with a reliable and secure investment option. The funds deposited in PPF accounts are backed by the government, ensuring a high level of safety for investors’ money.

• Tax Benefits:

Another objective of PPF is to offer tax benefits to investors. Contributions made to PPF accounts are eligible for tax deductions under Section 80C of the Indian Income Tax Act. The interest earned and the maturity amount are also tax-free, providing individuals with an opportunity to save on taxes.

• Fixed and Attractive Returns:

PPF aims to provide individuals with fixed and attractive returns on their investments. The interest rate on PPF is determined by the government and is typically higher than the rates offered by most fixed deposit accounts. The interest is compounded annually and credited to the PPF account, helping investors grow their savings over time.

• Financial Inclusion:

PPF is designed to promote financial inclusion by making long-term savings accessible to a wide range of individuals, including those from rural and semi-urban areas. PPF accounts can be opened at authorized banks and post offices across the country, making it convenient for individuals to participate in the scheme.

• Retirement Planning:

PPF encourages individuals to save for their retirement years. By providing a long-term investment avenue with tax benefits and attractive returns, PPF helps individuals build a retirement corpus and secure their financial future.

• Flexibility in Contributions:

PPF offers flexibility in terms of contribution amounts. Individuals can choose to invest a minimum of Rs. 500 to a maximum of Rs. 1.5 lakh per financial year. They can make contributions in a lump sum or in a maximum of 12 installments per year, allowing them to align their savings with their financial capabilities.

Types of PPF

There is only one type of Public Provident Fund (PPF) available, which is the regular PPF account. However, there are certain variations and categories within the PPF account that can be considered as types. Here are some variations within the PPF account:

1. Individual PPF Account:

This is the standard PPF account opened by an individual in their own name. It is meant for individuals to save and invest for their personal financial goals.

• Joint PPF Account:

Joint PPF account allows two or more individuals to open a single PPF account together. This account is typically opened by family members like spouses or parents and children. Joint PPF accounts have the same contribution limits and benefits as individual accounts but are managed jointly by the account holders.

• Minor PPF Account:

Minor PPF account is opened on behalf of a minor by their parent or legal guardian. The account is operated by the parent or guardian until the minor reaches the age of 18. After that, the minor can operate the account independently.

• PPF Account for HUF (Hindu Undivided Family):

PPF account can also be opened in the name of a Hindu Undivided Family (HUF). HUFs can utilize the PPF account to save and invest for the benefit of the family members.

Advantages of PPF

The Public Provident Fund (PPF) offers several advantages to investors. Here are some key advantages of investing in PPF:

• Tax Benefits:

Contributions made to a PPF account are eligible for tax deductions under Section 80C of the Indian Income Tax Act. Currently, the maximum deduction allowed is Rs. 1.5 lakh per financial year. The interest earned and the maturity amount are also tax-free. These tax benefits make PPF a popular choice for individuals seeking tax-efficient savings and investments.

• Guaranteed Returns:

PPF provides guaranteed returns on investments. The interest rate on PPF is determined by the government and is typically higher than those offered by most fixed deposit accounts. The interest is compounded annually and credited to the PPF account. The assurance of fixed returns makes PPF an attractive investment option for individuals looking for stable and secure savings.

• Long-term Investment:

PPF is a long-term investment avenue with a tenure of 15 years. It encourages individuals to develop a habit of disciplined and regular savings over an extended period. This long-term investment approach helps individuals accumulate a significant corpus for their financial goals, such as retirement planning, education expenses, or purchasing a house.

• Safety and Security:

PPF is a government-backed savings scheme, providing a high level of safety and security for investors’ funds. The funds deposited in a PPF account are backed by the Central Government, reducing the risk associated with the investment. This safety feature makes PPF a reliable option for risk-averse investors.

• Flexibility in Contributions:

PPF offers flexibility in terms of contribution amounts. Individuals can choose to invest a minimum of Rs. 500 to a maximum of Rs. 1.5 lakh per financial year. They can make contributions in a lump sum or in a maximum of 12 installments per year, allowing them to align their savings with their financial capabilities.

• Loan Facility:

After the completion of the third financial year, PPF account holders are eligible to avail of loan facilities against their PPF balance. This feature provides individuals with the flexibility to access funds during emergencies or financial needs while keeping their PPF account intact.

• Transferability:

PPF accounts can be transferred from one authorized bank or post office to another, providing flexibility and convenience to investors in managing their accounts. This feature allows individuals to maintain their PPF account even when they change their residential location.

• Financial Discipline:

PPF promotes financial discipline by encouraging individuals to make regular contributions over an extended period. The mandatory lock-in period of 15 years instills a disciplined savings habit and discourages premature withdrawals, ensuring that the funds are utilized for long-term financial goals.

Important Differences Between ELSS and PPF

Here’s a table highlighting the important features and differences between Equity Linked Savings Scheme (ELSS) and Public Provident Fund (PPF):

Key Differences Between ELSS and PPF

Here are some additional differences between Equity Linked Savings Scheme (ELSS) and Public Provident Fund (PPF):

• Investment Allocation:

ELSS invests primarily in equities and equity-related instruments, making it an equity-oriented investment option. On the other hand, PPF invests in government securities and bonds, making it a fixed income investment option.

• Returns:

ELSS returns are market-linked and can vary based on the performance of the underlying equities. The returns on ELSS investments are not fixed or guaranteed. In contrast, PPF offers fixed returns that are determined by the government and are generally higher than traditional fixed income options such as fixed deposits.

• Investment Flexibility:

ELSS offers flexibility in terms of investment amount and frequency. Investors can choose to invest a lump sum or through a systematic investment plan (SIP). There is no specific investment limit for ELSS. PPF, on the other hand, has a fixed minimum and maximum investment limit. Investors can contribute a minimum of Rs. 500 per year and a maximum of Rs. 1.5 lakh per year.

• Lock-in Period:

ELSS has a lock-in period of 3 years from the date of investment. Once the lock-in period is over, investors can choose to stay invested or redeem their investment. In contrast, PPF has a lock-in period of 15 years. However, partial withdrawals are allowed from the 7th year onwards.

• Tax Treatment:

ELSS investments are eligible for tax deductions under Section 80C of the Income Tax Act, up to a maximum limit of Rs. 1.5 lakh per year. The returns from ELSS investments are subject to long-term capital gains tax. PPF investments also qualify for tax deductions under Section 80C, and the interest earned and maturity amount are tax-free.

• Transferability:

PPF accounts can be transferred from one authorized bank or post office to another, providing flexibility and convenience to investors in managing their accounts. ELSS investments do not offer transferability between fund houses.

• Risk and Volatility:

ELSS investments carry higher market risk and volatility due to their exposure to equities. The returns on ELSS investments are subject to market fluctuations. PPF, being a fixed income investment, carries lower risk and volatility compared to ELSS.

Similarities Between ELSS and PPF

While Equity Linked Savings Scheme (ELSS) and Public Provident Fund (PPF) have some notable differences, there are also a few similarities between the two investment options. Here are some commonalities:

• Tax Benefits:

Both ELSS and PPF offer tax benefits to investors. Contributions made to both schemes are eligible for tax deductions under Section 80C of the Indian Income Tax Act. The maximum deduction allowed is Rs. 1.5 lakh per financial year for both ELSS and PPF.

• Long-term Investment:

Both ELSS and PPF are long-term investment options. ELSS has a minimum lock-in period of 3 years, while PPF has a lock-in period of 15 years. Both schemes encourage individuals to invest for the long term and build a corpus over time.

• Savings Discipline:

Both ELSS and PPF promote savings discipline. They encourage individuals to make regular contributions towards their investment goals. This disciplined approach helps individuals accumulate wealth over time and achieve their financial objectives.

• Fixed Investment Amount:

While ELSS offers flexibility in terms of investment amount, PPF has a fixed minimum and maximum investment limit. However, both options provide individuals with the option to contribute according to their financial capabilities.

• Risk and Returns:

ELSS and PPF offer different risk and return profiles. ELSS investments are subject to market risks as they are primarily invested in equities. On the other hand, PPF investments provide relatively stable and fixed returns determined by the government.

• Government-backed:

Both ELSS and PPF are backed by the government, providing a level of safety and security for investors. ELSS investments are made in mutual funds managed by asset management companies, while PPF is a government-run savings scheme.

• Contribution Modes:

Both ELSS and PPF allow investors to make contributions through various modes, such as cheques, cash, demand drafts, or online transfers. This flexibility makes it convenient for individuals to invest in both options.