Should you ditch PPF?

A few weeks back, a prominent person in MF industry published an article in Economic Times  arguing that investors should completely PPF in favour of equity funds (ELSS to be specific).

The primary argument was the PPF provides returns which may not beat inflation. Moreover, returns from equity funds have outperformed PPF over the long term.

This came at a time when PPF rates have gone down.  Many believe that the rate will go down even further.

During this calendar year (2016), the interest rates have come down from 8.7% p.a. to 8.1% and now to 8% p.a. Yes, the PPF interest rate was revised to 8% p.a. early this month (October 2016).

PPF has a lock-in period of 15 years (from the first investments). On the other hand, equity funds have no lock-in. ELSS funds have a lock-in of only 3 years.

So many issues with PPF.

Coming back to the titular question, should you ditch PPF and invest in equity funds alone?

I don’t agree.

Who is to say interest rates will never move up?

Though I am not an expert on interest rate movements, it may not be correct to assume that interest rates will never move up.

PPF rates have gone down because bond yields have gone down. Since the PPF interest rate is linked to 10-year Govt. bond yields (at least on paper), PPF interest has also been decreased. In fact, the Government has decided not to pass the entire hit to PPF account holders, otherwise the PPF rate would have been much lower.

And it is not that only the rates for PPF have gone down, interest rates for all the debt products have gone down. Interest rates for fixed deposits have gone down too.

Quite possible interest rate cycle may reverse in a few years and the rates may start rising. You would expect PPF interest rate to go up too.

Equity funds and PPF are two very different products.

PPF is a pure debt product. Comparing the returns with those of equity funds may not be the correct approach.

There will be times when PPF will outperform equity funds and there will be times when equity funds will outperform PPF.

I do concede equity funds have provided better returns than PPF over the long term.

However, have the investors been subjected to same volatility in both the cases?

With PPF, you get guaranteed returns. There is little risk of default.  Yes, the interest rate is decided by the Government every quarter but whatever is announced is guaranteed.

There is no such comfort with equity funds. It is easy to say that ELSS or equity funds have given far superior returns over long term. But how many of us had the conviction to stay invested for 15 years? There would have been many events in the interim that would have shaken your belief.

Many of us would have fallen for the temptation to book profits at some point or the other.

PPF does not test your patience and discipline to that extent.

You can’t ignore asset allocation

If you are focusing on asset allocation approach, how do you use ELSS to provide debt exposure? You simply can’t. That’s where PPF or EPF or any other good debt product may come in.

Similarly, PPF does not provide equity exposure. You may be the biggest fan of PPF but PPF can provide equity exposure in your portfolio. For equity exposure, you will have to go beyond PPF and look at equity funds.

Hence, both may have a role to play in your portfolio.

Will taxation always remain the same?

The Government wouldn’t dare taxation of PPF maturity proceeds. Government tried to tweak around taxation of EPF early this year (in Union Budget 2016). Amidst public outcry, the proposal had to be withdrawn in a hurry.  Of course, even the taxation of PPF can change. However, it will not be an easy decision for the Government.  Such decision will face great political opposition.

In my opinion, before the axe falls on PPF, it will fall on many other instruments.  Though I do not want to indulge in speculation, long term capital gains on equity funds will start getting taxed much before PPF maturity amount starts getting taxed.

As I understand, LTCG on sale of equity/equity shares was made exempt from tax only in 2004. Hence, such favorable tax treatment for equity funds has not been around forever. It is a recent decision, which can be clawed back.

Tax treatment of debt mutual funds was made adverse only in 2014. The holding period for units to qualify for long term capital gains was increased from 1 year to 3 years. Not outcry. Everybody quietly accepted the decision.

Do note the above aspect is nothing less than speculation on my behalf.

Lock-in period can be misleading

Under PPF, only first investment is locked in for 15 years. Investment in the 15^th year may face a lock-in of only a few months. Once you complete initial maturity of 15 years, PPF becomes very flexible.

In case of ELSS, every investment is subject to lock-in of 3 years. There is no lock-in period in equity funds apart from ELSS.

What should you do?

Stop comparing apples and oranges.

Unless you have huge wealth, follow a goal based planning approach.

Get your asset allocation right.

Consider equity heavy exposure for long term goals and debt-heavy portfolio for short term goals.

Equity heavy does not mean 100% equity exposure. Any portfolio requires regular rebalancing to align portfolio with desired asset allocation.

PPF may be a good fit in your debt portfolio for long term goals. If you have been investing in PPF for many years, you can invest in PPF even for short term goals.

PPF remains a brilliant debt product.  And I am sure it deserves a place in investment portfolios of most of us.

By the way, I am also not saying that invest everything in PPF. It is another matter that you cannot invest more than Rs 1.5 per financial year in PPF.

Exposure to equity funds is important but don’t ignore PPF either.

Both may have a role to play in your investment portfolio.

Additional Read

1. Article in Economic Times From Dhirendra Kumar, CEO, ValueResearch
2. PPF Rates go lower, and will go even lower