Why we need to use this feature of PPF more often!

Published: August 15, 2023 at 6:00 am

When it comes to the Public Provident Fund (PPF), investors typically focus on its tax-free, risk-free, and tax-saving benefits. Even those who cannot afford it often scrounge for Rs. 1.5 lakh for PPF investment within the first five days of the financial year. See: Investing Rs. 1.5 lakhs in PPF before April 5th may not be healthy for your portfolio! However, an under-appreciated feature of PPF is perfect for goal-based investing.

While most people believe that investing the maximum amount possible by April 5th or before the 5th of every month is the way to maximize the maturity value of PPF, this is not the ultimate goal of investing. There is a third and important way to benefit from PPF that is often overlooked.

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.

One cannot invest lakhs into PPF each year in the name of safety. This is the key reason asset allocation matters, and equity exposure becomes mandatory. It may be tax-free and risk-free, but too much of it will ensure we never change our social station. The same argument applies to those who invest in VPF.

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.

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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, and 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 come in. Suppose you start investing after appreciating inflation and asset allocation. You maintain a 50% equity portfolio and 50% fixed income, most of which are in EPF, NPS, or a gilt fund. See: Can we invest via SIP in gilt mutual funds for the long term?

You add a PPF account and keep it alive. The retirement goal progress is monitored yearly, and the corpus is “evaluated” yearly. 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 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.

Using PPF as a safe house for equity gains gives you enormous psychological benefits: “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). I had done enough goal-based investing calculators by this time to appreciate inflation and asset allocation.

So the equity allocation for this goal (unlike retirement) was 60%-ish from day one. Thrice, in the last 12+ years, I have maximised my son’s PPF account only by redeeming from equity. This is possible because of the right asset allocation -no PPF account is maxed. My mother’s 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 and 40% fixed income, the latter has enough to handle a UG education comfortably at today’s costs (my son is 13 with five years to college admission). 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 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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Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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