Small savings schemes have seen positive developments in the last two quarters as interest rates on various offerings were hiked. One exception that stands out in the entire situation is that of the Public Provident Fund, where the rates have remained stagnant at 7.1%.
This kind of static situation has an implication for investors because when the rates are not going up in a rising interest rate environment, they need to ensure that other investments in their retirement portfolio are making up for this.
PPF Investments
Investments in PPF have remained one of the top choices for investors who are looking for debt exposure as far as their retirement planning is concerned.
The salaried have the Employees Provident Fund, where an amount is contributed by both the employer and the employee and where the predominant exposure is to debt. Those who are not able to access the EPF look at the PPF as an alternative, and it is a safe and steady way to build a retirement corpus. While there is a tax benefit at the time of investment under Section 80C of the Income Tax Act, there is an additional benefit because the interest that is earned on the investment is tax-free.
These benefits make it a very attractive investment for those who fall in the higher tax brackets.
Rate Stagnant
The interest rate being offered on the PPF shows a clear divergence in terms of the movement of the interest rate as compared to other small savings schemes.
In the current rising rate cycle, especially in the last two quarters, the government has raised the interest rate on most small savings plans. The PPF is a notable exception, as the government has kept its interest rate unchanged at 7.1% since April 2020. The implication of this is that the entire upcycle in interest rates that happened over the last one-and-a-half years has left the PPF untouched.
It must be remembered that the interest rates were cut for the April to June 2020 quarter from 7.9% to 7.1%. This was because of the lower trajectory of interest rates seen in the economy, and while the fall in rates continued during the pandemic, the PPF rate remained static. This has brought the rates on the PPF to a multi-decade low. The last time it was lower than this was in 1976–1977, when the rate of PPF was 7%.
Whole Corpus
The change in interest rates is vital for the PPF as they impact the entire corpus of the investor.
The rate for the quarter affects not only the new amount of investment but also the whole amount that has been saved up to this point. This means that the impact for those who have a large corpus is huge, and this can have a big impact as far as the overall accumulation in the account is concerned. The scheme is a long-term one where there is an initial time period of 15 years, and then this can be extended in blocks of five years each for an unlimited number of times.
This makes it vital that it be considered a long-term investment from the point of view of financial planning.
Retirement Portfolio Strategy
The tax-free rate of 7.1% still compares favourably on a post-tax basis with the other debt options that are available currently, even after the rise in interest rates in the economy.
The individual's actual tax bracket will determine the net rate that they earn with taxable debt investments, but with fixed deposits and other debt investments seeing a rise in yields, the net rate for these instruments has also risen but is in a similar range. Investors, for their part, need to plan for the future because this is a long-term investment, and hence they need to ensure that they are sufficiently diversified as far as the debt exposure of their retirement portfolio is concerned.
They have to select multiple options for their retirement planning, including equity options, so that they are not limited by a single investment and the risks that arise from it.
Arnav Pandya is founder of Moneyeduschool.
The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.
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