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How to gain more from your investments?
The annual ceiling on investment in the Public Provident Fund (PPF) scheme has been increased to Rs 1 lakh from Rs 70,000. Also, the interest rate has been hiked to 8.6 per cent from the present 8 per cent.
While a tax free 8.6 per cent annually is good news for investors, this rate is applicable only for the current financial year. In other words, the rate of interest on PPF is going to be aligned with the rate on government securities (G-Sec), of similar maturity, with a spread of 25 basis points (bps). Hundred basis point is equal to one per cent.
In other words, the rate of interest on PPF, is no longer fixed. It is now floating or market linked. It's going to change every year and the applicable rate will be notified in the beginning of each financial year.
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How to gain more from your investments?
Needless to say, the changes brought about are extremely significant for investors. So far, long term instruments like PPF were largely being used to build one's retirement corpus or to meet other long-term financial goals such as marriage and education of children.
Till now, it was easier to plan with instruments like PPF, because there was an element of certainty involved - a specific amount growing at a specified interest rate for a specific number of years will compound to reach a specific goal.
Now, the 'growth rate' will not be specified and hence investors will require some recalibration in the financial plan.
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How to gain more from your investments?
A case in point is the Mehta family. Mr Mehta and his wife, in their mid-thirties, are parents to a three-year old daughter. Their combined income is Rs 1 lakh a month. After catering to household and other expenses like home loan repayment, they save around Rs 26,000.
One of their key goals is to provide for their daughter's education and marriage. For this, the Mehtas have a PPF account in the child's name. As the child is only three, the need for spending on higher education would arise 18-20 years later. The Mehtas contribute Rs 70,000 a year or Rs 5,800 a month in towards PPF.
Planning wise, upon the expiry of the initial 15 years, the Mehtas plan to extend contributions by another five years. At the rate of 8 per cent a year, till now the Mehtas were assured of a sum of Rs 32 lakh, 20 years hence.
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How to gain more from your investments?
But now, as the interest rate will be reset each year, the maturity value of the PPF corpus 20 years from now could be lesser than Rs 32 lakh or could be more. It all depends upon the interest rate movement over the next 20 years or so.
Due uncertain interest rates on PPF, the Mehtas may need to contribute to some other high growth instrument, which may help them if returns on PPF fail.
And given that education cost is sky rocketing, they will be better off with some extra contribution towards equity funds - diversified or index. With time in hand, they can easily fulfil their monetary needs 20 years later.
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How to gain more from your investments?
In case of 42-year old Mr Shah, PPF was a part of his retirement planning. Shah is a senior manager in a pharmaceutical company and his wife is a home maker. For his retirement corpus, Shah planned to augment his provident fund (PF) proceeds with PPF.
He recently also started a PPF account in his wife's name where he contributes Rs 70,000 a year. His plan was to primarily use his PF proceeds during retirement and have the PPF balance as reserve.
As the PPF account can be extended beyond its initial term, Shah's plan would have converted his wife's PPF into what would really become a five year fixed deposit, the funds of which were accessible at any given time.
Assuming that PPF account can be continued for 25 years, the Shahs would have had a sum of over Rs 51 lakh at their disposal (apart from the PF proceeds) during their retirement. To put it simply, the PPF money was meant as a retirement safety net.
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How to gain more from your investments?
Now since the structure of PPF hasn't been changed, the Shahs can still carry out their plan of keeping on extending the PPF account. However, they are faced with the same dilemma as the Mehtas.
They are no longer sure as to how much they would manage to salt away come the time. Will it still be over half a crore? Or, could it be more? What if the money turns out to be much lesser? Will a smaller safety net provide the same kind of security?
Well, there are no definite answers. Like they say, the only thing certain nowadays is uncertainty. And investors would do well to accept this uncertainty instead of fighting it. In other words, it is important to continue working along with the uncertainty, at the same time devising ways and means whenever possible of working around it.
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How to gain more from your investments?
For instance, just like in case of the Mehtas, Shahs could also look at diverting any surplus to equity diversified funds and/or index fund. Closer to the goal, both families can start moving the money to debt systematically.
An example of working along with the uncertainty is to continue your PPF investment. Just because the interest rate has become market-linked doesn't mean that you should abandon the instrument altogether.
At the same time, a way of working around the unpredictability of the instrument would be to review and re-look at the calculations every couple of years and make the necessary adjustments accordingly. If necessary, by all means seek the help of a professional financial planner and re plan your strategy to fulfil future goals.
At the end of the day, one just has the feeling that regardless of the actual rate, on a pure risk-return basis, PPF will continue with its significance and efficacy in any investor's portfolio.
The writer is director, Wonderland Consultants
