In the previous post in the ‘young earner’ series, I had listed down a set of personal finance essentials. Two points appear to have caught the eye of many readers.
- Do not open a PPF account
- Do not start a SIP in an ELSS fund
In this post I would like to expound on the first point. But first, a quick look at the second.
Do not start a SIP in an ELSS fund because each instalment will be lock-in for 3 years. Instead, open an account with an AMC, and invest every few months, on market dips, if possible.
This way, you get used to market volatility (train yourself to invest on dips), take control of your investments and make manual investing a habit.
Initially, the tax-saving serves as a carrot. Soon it will not be necessary. You will be control.
Let us now talk about PPF.
When I wrote, ‘Do not open a PPF account, I listed it against activity zero.
I meant a PPF account is not a prerequisite for investing.
- There is no hurry to open one.
- There is no need to include it as part of 80C deductions
- There is no need to invest to maximize investment in it.
Most people make the mistake of taking the benefits of a PPF account too seriously.
- 80C deduction
- EEE- taxation (investments, interest income and maturity amount are tax-free)
- Rs. 1.5 L invested each year for 15 years gets you 43.5L lakh at a constant 8% interest
All these are great features, but are they relevant for your financial goals?
A PPF account is suitable only for a goal which 15 full financial years away.
If we want to maximize the corpus for such a goal, we need at least 60-70% exposure to equity investments for such a goal.
Therefore, by focussing on ‘maxing’ our PPF account, it quite likely that we are not investing enough in equity.
When it comes to equity investing, time in the market maybe more important than timing the market, but
Time in the market implies capital in the market
That is, unless you maximize your invest in equity, time in the market is of no use.
Investing Rs. 1.5 lakh per year in PPF and starting a SIP for Rs. 2000 will most likely get you nowhere.
- If you need to invest Rs. 10,000 each month for a financial goal, 15 years away, invest about Rs. 3,000 in PPF and the rest in equity.
- If the goal is 20-25 years away (say, your retirement), invest only about Rs. 500/1000 (or less!) each month to PPF. Put the rest in equity. Remember your EPF (NPS in my case) will serve as the debt component.
In both cases, if your equity holdings increase in value sharply due a market surge, you can shift some gains from equity to PPF. This is referred to as one-way ‘rebalancing’
This is not possible if you are in the habit of investing Rs. 1 lakh (now 1.5 lakh) each April.
Rebalancing is a method by which you reset your asset allocation. If you started with 70:30, equity:debt ratio and after a year it is 75:25, rebalancing is the process by which you reset the allocation back to 70:30. If after a year it is 65:35, you again reset to 70:30. Learn more about it here.
It allows you to shift the fruit of compounding to safer instruments, increase capital in the under-performing asset (in the hope that it will pick up soon!). You can check out the rebalancing simulators at freefincal.
If you use PPF for your debt portfolio, you can shift from equity to PPF. You cannot shift from PPF to equity.
This is not a serious disadvantage but one-way rebalancing is way less optimal than two-way rebalancing.
A debt fund instead of a PPF could do a better job.
In fact, with a volatile debt fund like a long-term gilt fund, it is possible to shift gains (when interest rates fall) to equity.
- Use ELSS, term insurance premium and your EPF contributions for tax saving under 80C.
- Open a PPF account with a financial goal in mind. Not because it eligible for 80C deductions or for investing Rs. 1.5 lakh each year to get tax-free returns.
- Find out how much you need to invest for the goal, determine the equity:debt asset allocation and stick to it.
- Never withdraw from your equity holdings or PPF unless you really have to. The whole idea behind financial planning is to avoid such withdrawals. So ensure your personal finance essentials are taken care of. The same applies to a loan against PPF.