At 7.1% p.a., Should you invest in PPF?

If you are looking for a one-word answer, my answer is “Yes”. You must continue investing in Public Provident Fund (PPF).

In the remainder of the posts, we look at why.

PPF interest has been cut to 7.1% p.a. for the April-June 2020 quarter. This is the lowest PPF interest rate has ever been.

The impact of the rate cut in PPF and SSY (Sukanya Samriddhi Yojana) accounts is immediate i.e. you earn a lower rate of interest on the balance starting April 1, 2020. With deposit products such as SCSS, NSC, KVP and fixed deposits, you at least continue to earn the contracted rate until maturity.

No investor can be happy with a rate cut. For retirees and senior citizens, PPF can work both as a pension instrument and a risk-free tax saving investment. A rate cut means lower income. If you were gradually withdrawing from PPF for income, you would have to reduce your withdrawal.

For young earners, PPF finds a place in the debt allocation of the long-term portfolio and a tax saving investment. Their PPF balance would grow slower than it would have.

While a rate cut is not a happy situation, this was expected. In the year 2016, the Government had given guidance that the interest rates for the small savings schemes will be linked to Government securities of “comparable” maturity. It is another matter that the Government didn’t follow it.

I think 10-year G-sec bond yield is an appropriate benchmark. PPF was supposed to enjoy a spread of 25 bps (0.25%) and SSY was to enjoy a spread of 75 bps. Since the beginning of the year 2020, the 10-year G-sec yield has hovered between 5.99% and 6.69%, with the average being 6.42%. The current PPF rate is about 40 bps higher than the highest yield since the beginning of the year.

Still, 7.1% p.a. tax free is not bad.

What are your options?

When you are assessing an investment option, you must consider the alternatives. Do you have an alternative investment product that offers you a higher return at a similar risk profile? Let’s look at some of the options.

Note that some of the products may be available to only senior citizens.

#1 Senior Citizens Savings Scheme

The fresh deposits will be opened at 7.4% p.a. only. The interest is taxable. Therefore, if you are in higher tax brackets, you won’t be getting more than the PPF interest rate.

#2 Bank Fixed Deposits

The bank FD rates have moved down too since the RBI repo rate cut in the last week of March. The FD interest rate (SBI) ranges from 5.5% p.a. to 6.25% p.a. for various maturities. The interest is taxable too. Can’t match PPF.

#3 Pradhan Mantri Vaya Vandana Yojana (PMVVY)

You can earn 8% p.a. per annum for 10 years. The income is taxable. The problem is that PMVVY was open only until March 31, 2020. There has been no notification from the Government regarding the extension of the scheme. Therefore, you can count this option out. Even if the Government revives this scheme, the rate of interest is likely to be much lower than 8% p.a.

#4 RBI Savings Bonds 7.75% (Taxable)

Again, not sure whether these bonds will be offered at the same rate of interest. I could not find these for online subscription on the website of a prominent brokerage firm.

#5 Debt Mutual Funds

The above 4 options are without any risk. I assume the Government will save depositors in case of a bank fixed. Debt mutual funds, on the other hand, are risky. You have a lot of choice and it is difficult not to get confused. You need to select the right debt mutual fund for you. Going by returns alone is not a good choice. You can lose some serious money. This has happened with many schemes over the last couple of years. I have written about Vodafone downgrade and DHFL default in earlier posts.

Moreover, you shouldn’t compare apples and oranges. Why?

Because PPF is risk-free while a credit risk fund is not.

And you can’t compare future returns of PPF with past 1-year returns of a credit risk fund.

As the bonds in the debt fund portfolios come up for maturity, the proceeds will likely be reinvested at lower rates (re-investment risk). Thus, you can expect returns in debt mutual funds to move down too (if things stay this way).

#6 Corporate FDs/NCDs

These will offer a higher rate of interest, but you must see if you want to take that risk. The interest is taxable. There are some marquee names that offer these deposits. You can perhaps opt for those but appreciate the risk, nonetheless.

#7 Tax-Free Bonds

The yields are hovering in the range of 5.5% to 5.75%. PPF stands taller.

#8 Government Securities

You can invest directly in Government Bonds too through non-competitive bidding. However, it is unlikely that you would get any better rates than PPF. Moreover, the interest is taxable.

#9 Annuity Plans

Annuity plans from insurance companies can provide higher income if you are closer to or above 70 years. Annuity plans also lock-in the rate of interest for life, that even PPF can’t do. By the way, this won’t work for young investors. You need to structure the right annuity strategy for you.

As you can see, there are not many better options than the Public Provident Fund (PPF), even though the PPF interest rate has been sharply cut. Therefore, stick with PPF. It remains one of the best debt investments.

What you should not do?

You need to adjust to the new normal, especially if you are a retiree.

Don’t chase returns. Look at high yielding products with suspicion (this you must always do).

If your children feel that the current market fall is a once-in-a-lifetime opportunity and that you must invest in equities, don’t fall for it. You may neither have the risk-taking ability nor the risk appetite for equity investments.

If your friendly neighbourhood financial advisor is asking you to invest in debt mutual funds or equity mutual funds since the bank FD rates or the small savings schemes rates have been cut sharply, stay away.

If you are young, keep an eye on asset allocation. PPF rate cut is no reason to send more money towards equities.