Despite government’s U-Turn on small saving interest rates, don’t rush for PPF before April 5

Many investors invest entire lumpsum in PPF between April 1-4 because of the way interest is calculated. But a closer look at this strategy reveals it does not make much difference.

April 02, 2021 / 11:34 AM IST

Barely 12 hours after the government announced a massive cut in small savings interest rates, came the U-Turn. Early morning on April 1, the government rolled back the rate cuts. No, it wasn’t an April’s fool’s joke.

But for now, we must focus on the public provident fund (PPF), whose interest rate was also sought to be cut, but now reinstated. During the first 5 days of April every year, there assumes significance. If you know how PPF interest is calculated, then you would understand why many savers invest in PPF before 5th of every month. And some take it even further and invest full Rs 1.5 lac quota at the start of the financial year, i.e. between April 1-4.

But does it really matter as much? That you should lose sleep over this idea of investing Rs 1.5 lakh in PPF in the first few days of April? The month of April has just begun.

Before we discuss that, let us quickly see how PPF interest is calculated. This assumes significance as many people invest Rs 1.5 lakh in PPF before 5th April. The interest is calculated on a monthly basis on the minimum balance in the PPF account between the 5th and the end of that month. So if you invest after the 5th of a month, then you accrue interest on the previous month’s balance alone. But if you invest on or before the 5th, then you also get interest on the current month’s contribution in addition to the previous month’s balance. It is for this mathematical reason that investing before 5th of a month makes sense.

Also read: The government’s U-Turn on small savings interest rates: Should you continue with small saving schemes?

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PPF interest – the secret of April 1-4

Suppose your PPF balance on 31st March 2021 was Rs 10 lac. Now let’s compare depositing Rs 1.5 lac before 5th April and after 5th April 2021.

Suppose you invest Rs 1.5 lakh on April 3, i.e. before April 5. So the new PPF balance on 3rd April would be Rs 11.5 lakh (i.e. Rs 10 lakh from earlier plus Rs 1.5 lakh in fresh contribution). Now as per the rule, the minimum balance between April 5-30 would be Rs 11.5 lakh. So the monthly interest on the minimum PPF balance between April 5-30 would be (7.1%/12) * Rs 11.5 lakh = Rs 6,804.

Now let’s say that you delay be a few days and invest Rs 1.5 lakh on April 7, i.e. after April 5. The PPF balance on April 7 would be Rs 11.5 lakh. But the balance on dates 5th and 6th would still be Rs 10 lakh. Therefore, the minimum balance between April 5-30 would be Rs 10 lakh (on dates 5th and 6th as it increases to Rs 11.5 lakh only after 7th April). So the monthly interest on the minimum PPF balance between 5th and 30th here would be (7.1%/12) * Rs 10 lac = Rs 5,917.

As you can see, the difference ain’t much. And from next month onwards, the minimum balance every month would be the same as you would have already exhausted the full Rs 1.5 lakh limit in April itself.

Note - PPF interest is calculated monthly but credited only once at the end of FY. So there is no monthly compounding of interest.

To be sure, it’s not wrong to invest the full amount as early as possible in the financial year. I am just saying that it hardly matters. The difference in the final amount in either case is not very large. So it’s an unnecessary discussion in my view.

But if you can invest comfortably before 5th April, then go ahead and do it. But if you can’t, then it’s still fine. The interest you get will be slightly lower if you delay or stagger your PPF contributions.

Also read: Here are 3 options once your PPF account matures after 15 years

Despite government’s U-Turn, is PPF a good investment?

Also in this discussion of maximizing PPF returns by investing before 5th April, it should not be lost on investors that it is far more important is to ensure that they have proper asset allocation in your portfolio. PPF is a long-term instrument. But when investing for the long term, most investors need to have adequate exposure to equity to have a chance at getting inflation-beating returns.

Just investing in PPF won’t be enough for your goals.

Already provident fund rates are headed lower. As we saw, just a day back, the government decided to cut PPF rates drastically from 7.1% to 6.4% but for some reason (mostly political), decided to shelve the idea.

So you need to accept that sooner or later, risk-free PPF rates will head lower in this low-rate environment. As a result, you now need to invest seriously in other high-return potential options as well. Therefore instead of patting yourself for fully exhausting the PPF limit at the start of the financial year, figure out instead how much to invest in debt (like PPF, etc.) and how much to invest in equity and then invest accordingly under a proper asset allocation of goal-based financial plan.

The lure of trying to maximize PPF interest might be attractive but it won’t help you in the long run. So don’t invest in random goals like PPF interest maximization and end up missing forest for the trees.
Dev Ashish The writer is the founder of StableInvestor.com
first published: Apr 2, 2021 11:34 am
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