Readers who have been with the blog since it’s inception will know that PPF is one of my favorite debt instruments. New readers may want to read the post on Why you must invest in PPF. As this post attracted a lot of feedback and comments, I had to do A follow-up post on PPF. Finally as readers wanted to know how I had used PPF for my own financial planning, I did the final post on PPF – A personal perspective. Apart from these there are several other posts in my blog which will give you an idea about how you can use PPF in retirement etc. Read through them and you will realize the power of this simple but powerful investment. Now several people have asked me what is likely to happen to the PPF rates in the current interest rate regime and whether investing in it is still a good idea or not.
Before we get to the strategies of how to deal with PPF, let us first look at the historical rates of PPF over the last 30 years. It will be interesting to see that, in general, PPF rates have tended to be sticky and except for a brief period when the NDA government tried to link it to prevailing interest rates in the market, changes have been fairly rare. Look at the data:-
- Between 1986 and 2000 the rate was fixed at 12 %
- Between 2000 and 2003 it went down every year and dropped from 11 % to 8 %
- Between 2003 and 2011 the rate remained at 8 %
- Since 2011 the rates have not changed for long and stayed at 8.7 %
- With the market linking, the rates were really outside government control and dropped to 8.1 %, 7.8 % and 7.6 % in a few quarters
It is important to note that with the RBI signalling a turnaround in the interest rates of late and recommending that the small savings rate be bought in line with the bank FD rates, a change in the PPF rates is imminent. Politically the NDA formation believes in aligning rates of such instruments to the market rates, as they demonstrated the previous time, on the downward route. I fully expect the rates to go up to 8 % by end of year and maybe even higher around the next budget.
So what should a new investor do now? I believe that despite the rate cuts that will definitely happen from time to time, PPF remains the best debt instrument that you can invest in due to the EEE tax treatment that it gives you. Remember that you are getting less than 7.5 % from Bank FD and and after taxes it will only be a little more than 5 %, if you are in the highest tax bracket. You can invest in debt funds where the returns will improve with falling rates, but remember that with lowered inflation the cost inflation index will also increase less and the effective taxation of LTCG in debt funds may increase. Also, PPF is a long term instrument that builds investment discipline. But most importantly, over a period of time it builds you a suitable corpus that you can tap into at the time of your goals. should the time not be a right one for redemption of equities due to the markets doing badly. This is really the biggest risk in equity investment and PPF gives you a cover for it. My suggestion to all new investors will therefore still be to open a PPF account as early as they can and maximize their contribution there.
As far as existing investors are concerned, the choice is really simple. You should simply continue investing in it without worrying too much about the rates. You are doing this as part of a financial plan and need to stick with it. In the long term these changes in interest rates will keep happening and, despite the inevitable lower returns, PPF remains the most attractive instrument for the reasons mentioned earlier in the post.
The other aspect many investors have queries on is whether PPF is better than ELSS. I see this as a completely illogical comparison as the instruments below to completely different asset classes with diametrically opposite characteristics. You need to invest in BOTH equity and debt, it is never only one of them. Yes, they both qualify for 80 C deductions but that is about all. With capital gains from ELSS being taxed now, it makes more sense to choose the best equity MF possible and not be hamstrung to some ELSS fund just because you want to take the 80 C benefits. So go ahead and invest in PPF for debt and identify the best possible MF schemes for investing in equity. This combination is good and all investors must look at it.
In summary, do not get unduly excited by the coming rate changes of PPF to 8 % or greatly disheartened if rates again drop to7.5 % some quarters later. Continue with it if you are an existing investor and open a PPF account now if you do not have one yet. You will never regret it, I have not in 24 years.