Last Updated on February 12, 2022 at 6:14 pm
Let us consider the possibilities for an interesting question from Akash received a while ago. “It will take me 10 years to reach my asset allocation goal of 50% equity and 50% fixed income. Can I reduce this time by withdrawing whatever I can from PPF and invest in equity mutual funds? I shall also invest more into equity in future?” This is an important question because most readers would have already said a dismissive ‘no’ by just looking at the title. It is not as simple as that.
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Now, how does one arrive at a suitable asset allocation in the first place? This is the key to the whole question.
Obviously, this is a long-term goal. So, inflation is the benchmark for the overall portfolio return after tax. Let us assume inflation here is about 7-8% (Akash did not mention this).
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If the equity mutual fund return expectation is 10% (anything higher is dangerous. See: Do not expect returns from mutual fund SIPs! Do this instead!), the post-tax return would be about 9%.
If the post-tax return from debt is about 6% then for a 50:50 asset allocation the overall after-tax portfolio return is (50% x 9%) + (50% x 6%) = 7.5%. The catch is, one cannot maintain this 50:50 asset allocation throughout the investment tenure. The equity allocation needs to be lowered, and this means the portfolio return will decrease, and this decrease has to be factored in from day one. How best to lower this equity allocation requires special consideration too.
If an investor is starting from scratch, there is not much of a problem with these assumptions. Many young investors would say equity allocation should 80% or 70%, but as shown before, a 50-60% allocation works just fine: Will Benjamin Graham’s 50% Stocks 50% Bonds strategy work for India?
Older investors have a problem. The bulk of their investments would be in fixed income. At least for Akash, it would only take 10 years to set the equity to fixed income ratio to 50:50. Many can never reach their desired equity allocation!
Now, let us consider the question: Should I withdraw from PPF and invest in equity MF to reach my asset allocation goal?
The usual “it depends” response sadly is necessary here. Akash says it would take him 10 years to reach 50:50 asset allocation. Assuming this is done, we need to ask, how more time would be left to invest before the goal deadline?
Just 5 years left: The answer is obvious: Do not withdraw from PPF, reduce goal aspirations and assumptions suitably.
10 years left: The 50:50 allocation cannot be maintained for long at this level, even with 10-years left! So it still makes sense to leave the PPF as is and rework the goal calculation.
15 years left: The 50:50 allocation can be maintained for about 5 years. In principle, one can withdraw from PPF and invest in equity. How big a difference this would make should be assessed.
If not withdrawing from PPF would only cost you 1-2 years more to hit that 50:50 mark, it would be better not to withdraw. Why? We have got used to the safety of fixed income. Even if the interest rate has gone down, the credit at the start of the financial year lifts our morale. It is not each to go from this to uncertain returns and losses in equity.
Even if it is technically feasible, leaving PPF alone is the sensible choice from an emotional point of view. However, investors cannot hold on to all aspects of PPF investing. They must drastically reduce the amount invested into PPF (or VPF) in the future. See: Thinking of investing Rs. 1.5 Lakh in PPF this April? Don’t be in a hurry!
Also, they may have to do one or more of the following:
- Reduce goal corpus
- Extend goal deadline (if possible)
- Increase investible surplus. This reducing some expenses and/or increasing income.
It might seem trivial to say “don’t touch PPF”, but understanding the consequences of that is not so trivial. While planning for goals care is necessary to check how much your current investment would grow and contribute to the final corpus. How are we going to design asset allocation: for new investments or including old investments? The person who rushes to say “PPF is the best” will not do these calculations for you!
If you like to learn goal-based investing and portfolio management, you can start with this free seminar: Basics of portfolio construction: A guide for beginners.