Several decades ago, if one would have asked anyone for the best investment option, the first and foremost answer to come across would be the Public Provident Fund, also known as PPF.
First launched in the year 1968, the Public Provident Fund scheme aims to mobilize small savings by offering an investment with reasonable returns along with income tax benefits. The scheme is fully guaranteed by the Government of India and the balance in PPF account cannot be subjected to attachment under any order or decree of court except by Income Tax & other Government authorities for recovering tax dues.
Public Provident Fund Scheme, 2019 was introduced by the Government in December 2019, by making amendments to the earlier Public Provident Fund Scheme.
The reasons for the popularity of PPF back then could be attributed to the high-interest rates on investment (as high as 12% in the '90s) besides tax saving under Section 80C of the income tax act and tax-free amount on maturity. Of course, the greatest incentive was indeed the strong sense of security associated with PPF, being a government-backed instrument.
While the rest of the factors mentioned above are still relevant for an investor, PPF no longer offers a higher interest rate and the interest rates offered have been on a continuous downtrend over the last few years.
Now let’s first take a look at the history of interest rates offered by PPF.
Risk of falling interest rates
The above chart reveals how PPF interest rates have been on a continuous decline over the last few years. From an all-time high of 12% between 1986-2000 PPF rates have been falling over the previous two decades and is currently fixed at 7.1%.
Earlier, PPF interest rates were revised on a yearly basis. However, post-April 2016, the interest rates of PPF are revised every quarter linking it to yield of the 10-year government bond.
The below chart depicts the fall in 10-year government bond yields and the associated fall in PPF interest rates over the last few quarters.
With bond yields declining, further rate cuts in PPF interest rates cannot be ruled out. Looking at the current trend, it may be entirely possible that PPF interest rates could go below 7% in the coming days and if it does it may be the first time since 1974.
Don’t forget the real rate of return while investing in PPF
With inflation in the range of 5-6%, the real rate of return on your PPF investment (current 7.1% minus 5-6%) is just 1-2%. Such a low real rate of returns can never help one to create adequate wealth.
Investing in PPF is indeed a great way to strengthen one’s debt portfolio, given the safety associated with it and its tax-free returns. However, investing in PPF or any other instrument with low returns for security or tax-free returns can never help in creating wealth.
Depending on one’s age and the time horizon for investment, the investor should allocate some percentage of investment to equity investments too as history reveals that it has outperformed the returns generated by all other asset classes till date. Experts recommend that the ideal proportion of your investment to be allocated to equity should be your age minus 100. So, if your age is 30, you should allocate 70% of your investments to equity, and the rest 30% can be invested in PPF or similar instruments.
There is absolutely no doubt that equity investments are subject to market risks due to its volatile nature; however, over the long term, the risk is significantly less. In contrast, the potential for returns is very high.
Long term investments in fundamentally sound stocks like Maruti, HDFC Bank, MRF, Eicher Motors, Page Industries, Infosys, Wipro etc. have multiplied investor wealth by multiple times. This kind of returns is merely unimaginable while investing in PPF, fixed deposits or other small saving schemes like Kisan Vikas Patra or post-office deposits.
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