PPF vs. Equity: Where should I invest?

On Aug. 25th 2014, the Economic Times carried an article titled, PPF investment can beat Sensex returns over 20-year period. They showed that between Aug. 1994 to Aug. 2014, Sensex returned an annualized return of 9.15% while the PPF returned 10.46%.

Needless to mention this article created a lot of buzz among investors and distributors. Investors panicked and wondered if they were right to have started that SIP a few months ago.

Five days later, the distributor portal CafeMutual carried an article  (Can PPF beat Sensex returns over 20-year period? ) whose sole purpose was to debunk the Economic Times article.

The CafeMutual article pointed out that only one time period was considered by the ET correspondent and that dividends from the Sensex were ignored.

Therefore in order to disprove the ET article three different dividend yields were added to the Sensex CAGR of 9.15% to ensure it is higher than PPF.

Now everyone can rest easy. Equity is the better instrument! So why write another post on the subject?

Fair question. Let us begin by quoting some important lines from the ET article which seems to have escaped the attention of those who found it troubling.

"While this study is no suggestion that a PPF is a far better option than equities at all times, it just reinforces the fact that timing is critical in the capital market. Despite the recent rally, Sensex's annualised return for a period of seven years is only 8.10%, if you have entered at the fag end of the previous rally (i.e., in August 2007)."
 
"....retail investors who are entering the ring now need to be mindful of the fact that they may not get the kind of returns from equities as seen in the recent past. In some instances, it also doesn't make much sense being a long-term investor in equities"
 

Amusingly, the Cafe Mutual article has the following to say:

".... our attempt is not to prove that equity would always outperform PPF for periods as long as 20 years, since we have also presented only one data point. The idea is not to prove equity as superior to anything else, but to highlight the fact that if some part of the data is ignored (dividends) , a totally different picture may emerge. Equity is a risky asset class and hence one should not expect 100% guarantee of positive returns, whatever the period."

Then it goes on to state,  "PPF investment can beat Sensex returns over 20-year period - it can, but not this time…" (in the above mentioned period)

Now let us satisfy our curiosity by looking at all possible 20 year CAGR constructed out of Senex returns for all financial years from 1979-80. The period covered is different that considered above, but that should not make too much of a difference.

PPF-vs-Equity

This chart was constructed with the Excel sheet available at: Understanding the Nature of Stock Market Returns

A notional 2% dividend was added.  It does not matter though. I think it is safe to say that PPF has beat the Sensex over only one 20Y period (the one surrounded by a green rectangle).

So shall we rejoice? Rest easy and assume that our equity  SIPs will definitely beat PPF returns? Shall we emphatically state that equity will beat returns from fixed income instruments?

Not so fast. Do so at your own peril.

Let us assume you will have to pick a stone, eyes closed, from a box containing black and white stones. Pick a white stone, you win. Pick a black stone you lose. History suggests that white stones were picked more often than black stones.

I cite this fact and persuade you to pick a stone.  Will you pick with the confidence that you cannot lose because most people who have picked in the past have not lost?

Equity investing is not very different.

Notice the spread in the above returns. The maximum return (before dividends) is 20% and the minimum return is 7%.

So clearly the return depends on when the investment begins. It does not matter whether it is a lump sum or SIP. In equity investing, the sequence of returns determines the final returns. This is crudely referred to as 'luck' or 'market timing'.

This is the main message of the ET article: returns depend on when you start investments. Sometimes one can beat PPF and sometimes not. Past performance is irrelevant.

If I were a mutual fund distributor, I will choose to ignore this fact. Since I am a retail investor, I cannot afford to ignore it.

The huge spread in returns observed in the past is the reason why equity investments must be regularly monitored and course-corrected.

It is beyond naive to assume that letting a SIP run in a mutual fund for years will get the job done.

Comparing a fixed income instrument with an unmonitored equity instrument serves only one purpose: It serves as a reminder that volatile instruments must be monitored!

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42 thoughts on “PPF vs. Equity: Where should I invest?

  1. Jay

    Nicely written article. Not a fan of luck or timing since there is no actionable for me - is there something common to those start years when returns were highest? Were those the dip or sideways movement years? Maybe we can find a pattern to this 'luck' or 'market timing'.

    Reply
  2. Jay

    Nicely written article. Not a fan of luck or timing since there is no actionable for me - is there something common to those start years when returns were highest? Were those the dip or sideways movement years? Maybe we can find a pattern to this 'luck' or 'market timing'.

    Reply
  3. Ram

    Equity investment is one of the most poorly understood investment avenues and continues to be either unreasonably praised or wildly denounced. Many months of reading, observation and practical knowledge with small experimental investments will tell you whether this is for you or not? The general pros and cons are well known. How one wishes for omniscience.

    Reply
  4. Ram

    Equity investment is one of the most poorly understood investment avenues and continues to be either unreasonably praised or wildly denounced. Many months of reading, observation and practical knowledge with small experimental investments will tell you whether this is for you or not? The general pros and cons are well known. How one wishes for omniscience.

    Reply
  5. Indra

    Equity investment has inherently more risks - than provident fund. Hence there are promise of more returns but thats a promise - not a guarantee.
    But the article in ET did compare apple vs oranges.
    For one thing, PPF interest is fixed by one government. Unlike the CAGR offered by equity market. Then there is the dividend reinvestment, biased sample size. The biggest difference is they are at different ends of the risk spectrum.

    Reply
    1. pattu

      Agree. Unfortunately most people assume the 'promise' means a guarantee! Hence such articles create a sensation.

      Reply
  6. Indra

    Equity investment has inherently more risks - than provident fund. Hence there are promise of more returns but thats a promise - not a guarantee.
    But the article in ET did compare apple vs oranges.
    For one thing, PPF interest is fixed by one government. Unlike the CAGR offered by equity market. Then there is the dividend reinvestment, biased sample size. The biggest difference is they are at different ends of the risk spectrum.

    Reply
    1. pattu

      Agree. Unfortunately most people assume the 'promise' means a guarantee! Hence such articles create a sensation.

      Reply
  7. bharat shah

    all readers may have read comments of subra on it in his recent post ,but just for record:
    ' If you had invested in 1994 till the year 2014 you earned LESS than PPF: Only an absolutely idiotic person can write such an article. One needs to remember that even the index scrips would have paid about 3% annual dividend. Now if this dividend was REINVESTED in the same index, the returns would go up to about 7-8% over a 20 year period. ET’s Innumeracy.'
    thank you for digging deep.

    Reply
  8. bharat shah

    all readers may have read comments of subra on it in his recent post ,but just for record:
    ' If you had invested in 1994 till the year 2014 you earned LESS than PPF: Only an absolutely idiotic person can write such an article. One needs to remember that even the index scrips would have paid about 3% annual dividend. Now if this dividend was REINVESTED in the same index, the returns would go up to about 7-8% over a 20 year period. ET’s Innumeracy.'
    thank you for digging deep.

    Reply
  9. Deep

    92-94 period sensex PE was at abnornal valuation sometimes crossing 50!.Those were just post the 1991 reform days a very shallow market exposed to global liquidity available plus adding fuel to the fire were guys like Harshad Mehta.No wonder the returns were so miserable for anyone buying a market at that PE.Today inspite of a 44% rally in a year sensex is around 19 PE.The article in ET is a classic case how to spread financial illiteracy.

    Reply
    1. pattu

      Deep, shall we then assume that it is impossible for someone invested in a Sensex index fund to get returns lower than PPF?

      Reply
      1. Deep

        Obviously no,depending on point to point comparison argument can be built that this is "THE" asset class for any asset class.The flaw lies in trying to generalise it.The case for equity for long term wealth creation is not built on one data set but after taking into account a huge series of data set.There is no other asset class which can capture productivity growth as equity can.However as u mentioned monitoring is needed.

        Reply
        1. pattu

          Agree. That is from the point of view of an analyst. From the point of view of an investor, if I see a single duration in which the return sucks, that should be enough of a sign to stay on guard.

          Reply
  10. Deep

    92-94 period sensex PE was at abnornal valuation sometimes crossing 50!.Those were just post the 1991 reform days a very shallow market exposed to global liquidity available plus adding fuel to the fire were guys like Harshad Mehta.No wonder the returns were so miserable for anyone buying a market at that PE.Today inspite of a 44% rally in a year sensex is around 19 PE.The article in ET is a classic case how to spread financial illiteracy.

    Reply
    1. pattu

      Deep, shall we then assume that it is impossible for someone invested in a Sensex index fund to get returns lower than PPF?

      Reply
      1. Deep

        Obviously no,depending on point to point comparison argument can be built that this is "THE" asset class for any asset class.The flaw lies in trying to generalise it.The case for equity for long term wealth creation is not built on one data set but after taking into account a huge series of data set.There is no other asset class which can capture productivity growth as equity can.However as u mentioned monitoring is needed.

        Reply
        1. pattu

          Agree. That is from the point of view of an analyst. From the point of view of an investor, if I see a single duration in which the return sucks, that should be enough of a sign to stay on guard.

          Reply
  11. shikhar

    Excel is a real magic. People enter different "Historical data" and with some "assumptions" and get desired results, to prove one option is right and another option is wrong (Equity or Debt).

    Reply
    1. pattu

      True but why blame Excel for it? If an analyst chooses to put the cart before the horse, only a trail of dung will ensue.

      Reply
  12. shikhar

    Excel is a real magic. People enter different "Historical data" and with some "assumptions" and get desired results, to prove one option is right and another option is wrong (Equity or Debt).

    Reply
    1. pattu

      True but why blame Excel for it? If an analyst chooses to put the cart before the horse, only a trail of dung will ensue.

      Reply
  13. mono

    A fraudster did this
    he took 100 rupees from a person to invest in equities..
    instead he invested in FD's..and said after 2 months that stock markets crashed...and the value of equity is now gone from 100 => 20..and till 2 years it remained like that at 20..by this time the FD have become 120 rupees..and then the fraud said..oh stock markets have become booming..it now gone up from 20 => 60..so he get to keep 60 rupees...

    paisa kamane ka ek hi tareeka hain...
    MEHNAT ...AUR...BACHAT...

    Reply
  14. mono

    A fraudster did this
    he took 100 rupees from a person to invest in equities..
    instead he invested in FD's..and said after 2 months that stock markets crashed...and the value of equity is now gone from 100 => 20..and till 2 years it remained like that at 20..by this time the FD have become 120 rupees..and then the fraud said..oh stock markets have become booming..it now gone up from 20 => 60..so he get to keep 60 rupees...

    paisa kamane ka ek hi tareeka hain...
    MEHNAT ...AUR...BACHAT...

    Reply
  15. Soman

    This is the most unbiased view on that ET article I have seen (most others are violent comments from mutual fund distributors out to protect the lie they were spreading for so long (ie that equity is always good irrespective of the market situation). But you also analysed a part of the article that appeared on ET main paper and not the full article that appeared on ET Wealth on the same day (link give below). Please let me know your views on that also.

    http://economictimes.indiatimes.com/markets/stocks/news/why-buy-and-hold-isnt-as-good-a-strategy-as-timely-churning-of-portfolios/articleshow/40768289.cms

    Reply
  16. Soman

    This is the most unbiased view on that ET article I have seen (most others are violent comments from mutual fund distributors out to protect the lie they were spreading for so long (ie that equity is always good irrespective of the market situation). But you also analysed a part of the article that appeared on ET main paper and not the full article that appeared on ET Wealth on the same day (link give below). Please let me know your views on that also.

    http://economictimes.indiatimes.com/markets/stocks/news/why-buy-and-hold-isnt-as-good-a-strategy-as-timely-churning-of-portfolios/articleshow/40768289.cms

    Reply
  17. Veda

    Nice article. I have one basic question concerning monitoring SIP every year. Let's say SIP1 has been doing extremely well for about 5 years and it's performance dropped from 6th year onwards even though market has been moving uphill during that eventful year. What shall be the suggested course of action here for a long term investor who wishes to stay invested/SIPed for 15 years - Stop SIP1, take entire amount (invested for 5 years) out and use proceeds in some other SIP2 which has a successful track record? Or leave SIP1 amount as it is and start SIP afresh in SIP2? Appreciate your response.

    Reply
    1. pattu

      A fund doing badly when the market is moving uphill is extremely rare! Such would not have performed well during the first 5 years as well!
      What matter is the net CAGR of the portfolio corresponding to a goal. Is the CAGR above your expectation or close to it? If yes, then not much change is required. If the fund is doing poorly, the investor must investigate the reasons for this before deciding to switch or stay. See the latest post on star ratings in this regard.

      Reply
      1. Veda

        Thanks for your response. I understand your point of view but would like to know extended action of switch or stay - When you say switch, does it mean we should sell off units in its entirety for the weak fund and move proceeds to a new fund with an impressive track record? Or start investing (new SIP) in a new fund and stop making additional investment altogether in the weak fund but leaving existing units untouched (staying invested) for a year or so ?

        Reply
        1. pattu

          Difficult to provide a single route. If the fund is underperforming, but if you believe in the fund, you can invest elsewhere while retaining units in the old fund. Otherwise you can switch completely. If one already has many funds, switching is better!

          Reply
  18. Veda

    Nice article. I have one basic question concerning monitoring SIP every year. Let's say SIP1 has been doing extremely well for about 5 years and it's performance dropped from 6th year onwards even though market has been moving uphill during that eventful year. What shall be the suggested course of action here for a long term investor who wishes to stay invested/SIPed for 15 years - Stop SIP1, take entire amount (invested for 5 years) out and use proceeds in some other SIP2 which has a successful track record? Or leave SIP1 amount as it is and start SIP afresh in SIP2? Appreciate your response.

    Reply
    1. pattu

      A fund doing badly when the market is moving uphill is extremely rare! Such would not have performed well during the first 5 years as well!
      What matter is the net CAGR of the portfolio corresponding to a goal. Is the CAGR above your expectation or close to it? If yes, then not much change is required. If the fund is doing poorly, the investor must investigate the reasons for this before deciding to switch or stay. See the latest post on star ratings in this regard.

      Reply
      1. Veda

        Thanks for your response. I understand your point of view but would like to know extended action of switch or stay - When you say switch, does it mean we should sell off units in its entirety for the weak fund and move proceeds to a new fund with an impressive track record? Or start investing (new SIP) in a new fund and stop making additional investment altogether in the weak fund but leaving existing units untouched (staying invested) for a year or so ?

        Reply
        1. pattu

          Difficult to provide a single route. If the fund is underperforming, but if you believe in the fund, you can invest elsewhere while retaining units in the old fund. Otherwise you can switch completely. If one already has many funds, switching is better!

          Reply
  19. Himanshu Pant

    Sir so I believe the underlying concept is that on a long enough time line (min 10+ years) equity mf will be able to weather market ups and downs and give positive returns . Your CAGR analysis for 10+ years seems to indicate this

    Reply
  20. Himanshu Pant

    Sir so I believe the underlying concept is that on a long enough time line (min 10+ years) equity mf will be able to weather market ups and downs and give positive returns . Your CAGR analysis for 10+ years seems to indicate this

    Reply

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