PPF v/s Equity Mutual Fund| Is it a Right Comparison?

Comparing Public Provident Fund (PPF) & Equity Mutual Fund

Introduction

In this article, we are going to compare PPF v/s Equity Mutual Fund, which have delivered lower returns than the PPF in the last five years.

PPF v/s Equity Mutual Fund|Is it a Right Comparison?

Understanding PPF & Equity Mutual Fund

• Public Provident Fund (PPF) is the traditional and popular way of making investment in India. The investors investing are eligible for claiming the tax deduction under section 80C of the Income Tax Act, 1961. It encourages the taxpayers to build funds for their retirement. The investment in PPF is supported by the Government of India (GOI). In short, it is a risk- and tax-free debt instrument.
• Equity Mutual Fund is the another way of investing in the stock market, apart from going for direct stock investment. The major advantage to the investor is when the investor is not much aware of how the stock market works; they can approach the MF houses for their fund investment in the equity.

Comparing PPF v/s Equity Mutual Fund

Average Returns for Last 5 Years

• The interest rate for PPF is typically in the range of 7.5% to 9%. The average PPF returns in last 5 years is 8.21%.
• On the other hand, the five-year average returns of diversified equity mutual funds as of 30 August 2019 is around 8.5% to 10%. These rates are annualized. There are some mutual funds which have given returns more than 10-12%. But, we should always consider the average returns for the sake of proper ground level comparison.
• Although the pre-tax returns of Equity Mutual funds look higher, investors should note that equity funds carry a 10% tax on gains above ₹1 lakh. PPF interest, on the other hand, is tax-free.

Earnings Visibility

• When we consider the earnings visibility of PPF investment, interest rates come into the picture. PPF offers fixed interest rates, which is linked to the repo rate.
• Due to the demand slowdown and weakened private consumption, RBI has adopted the Accommodative stance and is executing a repo rate cuts successively since last 3 monetary policy meets (April-19, June-19, August-19). The current Repo rate is at 5.40%.
• So, with the downward interest rate trend with the successive repo rate cuts, PPF rates are also going down hand-in-hand. It clearly shows PPF will offer lower returns in future because of its reduced earnings visibility.

Investment Limit

You can invest in PPF per PAN maximum up to Rs.1.5 Lakh per annum only. One should take into account the investment limit of Rs.1.5 Lakh is for both yourself as well as as a guardian for your children.

Sluggishness in Equity Market for Last 1.5-2 years

• When we compare the 5-year average returns of PPF and Equity mutual funds, the Sluggishness in Equity Market for Last 1.5-2 years should be taken into the consideration. Equity returns are volatile by definition and mainly impacted by negative market sentiments.
• The erosion of equity mutual funds returns is mainly due to slower economic growth since last few quarters. Economic slowdown was mainly resulting from demonetization and poor implementation of GST.
• This situation of slowdown would be recovered with the reforms and with the demand as well as investment growth. The long-term prospects of the economy would be better with the implementation of these reforms and improvement in the market sentiments.
• And here, Equity will be the first mover in terms of returns. Equity returns have always beaten the other fixed income savings schemes in the improving and the rising equity markets.

Asset Allocation Strategies – The Best Long-term Solution

• In asset allocation strategies, the best strategy is Constant Weight Asset Allocation Strategy. In this, human intervention should be zero. The investors should decide the proper algorithms right from start of investment.
• For Example, The investor have chosen Equity : Debt allocation to be 50% : 50% according to his risk appetite. Then he should review his asset allocation half-yearly or yearly. With the appreciation in the equity and debt investment value over the review period, the investor should re-balance his portfolio accordingly to the same earlier 50%-50% weight.
• Thus, if the equity investment is at higher value than that of debt (That is capital appreciation in equity is greater than debt), then you should sell equity at higher level and invest that amount into debt.
• If Debt’s capital appreciation is greater than equity at the time of review, then the debt investment should converted into equity by purchasing more equity at lower cost to re-balance the portfolio again at 50%-50%.
• In this way, you can eliminate the human interventions and the consequent behavioral decisions resulting from the market sentiments.