This useful feature of PPF deserves more attention!

Published: August 8, 2020 at 10:38 am

When it comes to the public provident fund (PPF), investors tend to focus on its risk-free, tax-free and tax-saving benefits. In fact, even those who cannot afford to do so, scour around to find Rs. 1.5 lakh for PPF investment within the first five days of the financial year (which incidentally could be a mistake!). There is an under-appreciated feature of PPF that hides in plain sight which is perfect for goal-based investing.

Ask anyone how to use a PPF account, they would tell you, (1) invest the maximum amount possible each financial year; (2) do so either by April 5th or before the 5th of every month. Yes, this is the way the maximise the maturity value of PPF, but that is not the goal of investing! There is a third, important way to benefit from PPF.

In spite of its tax-free nature, PPF is unlikely to beat inflation – not because of gradually falling interest rates, but because of the maximum investment limit. An investor cannot say, “I am scared of capital markets. I want 100% safety” and throw money at the problem.

That is, one cannot invest lakhs into PPF each year in the name of safety. This is the key reason why asset allocation matters, why equity exposure becomes mandatory. It may be tax-free and apparently risk-free, but too much of it will ensure we never change our social station in life.

As we saw recently – Why Benjamin Graham’s 50% Stocks 50% Bonds strategy works! – a 15- year goal ( or longer, why else would you use PPF?) requires at least 50% in equity and 50% in fixed income.

So what is this third way? No, it is not asset allocation. We have talked about that enough! The third way is this well known PPF rule: the minimum investment is Rs. 500 a financial year! How this is a benefit you might ask.

I could start a PPF account, invest Rs. 500 for the first 14 years, invest Rs. 1.5L in the 15th year. This flexibility is rare and not often exploited. A fixed deposit or recurring deposit or an insurance premium does not have this. If the term of investment is fixed, the amount is also fixed – lump sum or recurring.

How is this a benefit when you are actually investing lesser than you can? This is where proper goal-based investing and asset allocation comes in. Suppose you start investing after appreciating inflation and asset allocation. You maintain a 50% equity portfolio and 50% fixed income most of which is in EPF or NPS or a gilt fund. See: Can we invest via SIP in gilt mutual funds for the long term?

You add a PPF account, but just keep it alive. The retirement goal progress is monitored each year and the corpus “evaluated” each year. See: Review Your Financial Freedom Portfolio in Seven Easy Steps. After a few years of investing and regular rebalancing, the equity portfolio sees an excellent year with 90% annual gains.

You decide to reduce equity allocation and lock away the gains in a “safe place”. PPF is a natural choice to do this. You can invest Rs. 1.5L in say your account and another Rs. 1.5L in your spouse’s account.  Income clubbing rules would apply, but since PPF is tax-free it is only a matter of appropriate reporting in ITR. This is only possible if you do not rush to max your PPF accounts each year.

By using PPF as a safehouse for equity gains, you gain enormous psychological benefit: “I made my money work hard, I took a big risk and now the reward is safe”. Note that this has to be done from the point of view of the goal and not randomly, not each time there is a good equity year.

As freefincal regulars may be well aware, I have used this idea to minimise risk from my son’s future goals portfolio. I started investing in Dec 2009 (a month before he was born). By this time, I had done enough goal-based investing calculators to appreciate inflation and asset allocation.

So the equity allocation for this goal (unlike retirement) was 60%-ish from day one. Twice in the last 10+ years, I have maximised my son’s PPF account only by redeeming from equity. This is possible because the right asset allocation -no PPF account is maxed. My mothers PPF account is also tagged to this goal and was started only for this purpose. The two PPF accounts + an arbitrage fund (also created from booked profits) maintain fixed income allocation.

This way, although the asset allocation is still 60% equity, 40% fixed income, the latter has enough to handle a UG education comfortably in today’s costs (my son is 10 with 8 years to college). This allows me to take on the risk of poor equity returns with peace of mind.

Please note I am referring to goal-based portfolio de-risking here and not rebalancing. Although a PPF is partially liquid after seven years, a gilt fund is better suited for the annual rebalancing of a long-term portfolio. This “shifting gains to PPF” is meaningful only if you track the goal corpus growth and are aware of “where you are” at any point in time.

We need to step away from the mindset of maximising security each year to maximising security when it matters the most. PPF allows us to do this if we have the right priorities.

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