Friday, January 29, 2016

PPF only may be insufficient for your Retirement

I am sure that I am committing blasphemy if I were to make such a claim in any other country. PPF has been unquestionably part of every person’s long term financial planning in this country.
PPF has been a mainstay for many in India where there is no formal social security system.  More often than not, it is the parents who insist upon opening a PPF account for their child when they receive their first salary. While many open a PPF account in their child’s name as soon as they are born so that the maturity coincides for their higher education requirement.
Well, nothing wrong with this investment being a de-facto instrument in many investors’ portfolio.
Following may be considered as the reasons why PPF is popular:-
  • It disciplines you to remain invested for 15 long years. Money is hardly withdrawn from this account even during emergency, 
  • A habit of regular investments year on year is inculcated as a part of annual tax saving ritual.
  • Unlike other fixed interest options, interest on PPF is exempt from tax and so is maturity.
  • It is backed by sovereign guarantee and cannot be attached by Income Tax department.

But is PPF by itself, good enough to build a suitably large retirement corpus?

We at AIMS have believed that a portfolio should be built keeping in mind the risk profile of the investor. We have always felt that a person should invest in fixed interest securities if the goal is 1-3 years away; and equity should be the preferred choice if the goal is long term (viz upwards of 5-7 years). We have been taught that debt is safe in short term, but riskier in long term as it may not be able to beat inflation over a longer period.  The opposite is true for equities----less volatile in the long term.

By the above logic, PPF goes against the basic tenets of long term investing.

The other argument against PPF is that it runs the interest rate risk though not many realize it. With effect from December 2011, PPF interest rates have been linked to the prevailing interest rates in the economy—in other words they are no longer fixed. This means that PPF rates change every year and the new rate becomes effective at the beginning of every financial year. The new rates are applicable for the entire accumulated corpus. In a falling interest rate scenario as is the case at present, this may become quite unattractive.

Therefore, if an investor is able to stomach some risk, she should definitely consider a higher exposure to equity as that will provide higher long term returns, which is what is needed to build a healthy retirement corpus.

Honestly speaking, we have not been a great proponent of PPF. Data prove our belief. A better option can be ELSS funds under Section 80 C though not so popular. They have been around for roughly 20 years now, but are not so popular despite having a stellar track record. 

An ELSS fund which recently completed 19 years grew by 94 times over 19 years, which works out to 26.82% CAGR (compounded annual growth rate)

If someone has been investing an annual amount of Rs. 10,000 in PPF for the past 20 years, then his total investment would have been 2 lakh and the corpus in PPF would have been a modest Rs. 5, 15,035 as on 30 September 2015.The same annual investment in the above mentioned tax saving fund would have created a massive corpus of Rs.42, 90,480. The irony is that hardly anyone knows about this even though the data is available in the public domain.

The above data convincingly proves that equity scores much higher than debt in the longer term. One may, of course, question that the fund I have chosen may be a better performing fund and so there may be a bias. I analyzed the performance of all the 12 tax saving funds over a 15 year period starting from March 2000 to March 2015. The best performing fund generated 22% CAGR, while the worst gave a paltry 7.68% CAGR. The median performance was around 15%, which is much higher than the returns earned in PPF.

Finally, I want to conclude by saying that while PPF may seem safe, the question you need to ask yourself is whether you will be able to meet your retirement goals with it considering the lifestyle inflation we are exposed to.

The choice is yours, as the money is yours.