How to use EPF, PPF, and NPS (G+C) to handle the debt side of your long-term portfolio

Given the sovereign guarantee and tax-free nature of both instruments, EPF and PPF should form the core of your debt portfolio.

In all the discussion and noise about investing in mutual funds (MFs) and equities for the long term, sometimes the role of debt in the portfolio gets ignored. But debt is important. Unlike the legends of the stock market, investing everything in an equity portfolio isn’t most people's cup of tea.

For a long-term portfolio and during the accumulation period, investors have quite a few choices for investing in debt. These include the Employees Provident Fund (EPF), the Voluntary Provident Fund (VPF), the Public Provident Fund (PPF), bonds, the National Pension Scheme (NPS) (G + C schemes), and debt funds.

So, how should one go about using these debt instruments to invest for the long term, considering that sufficient allocations to equity have already been made via investments in equity funds?

Also read: Is it okay to invest everything in equities?

EPF + PPF should form the core

The EPF is a retirement fund for employees of the organised sector. Every month, a part of the salary is contributed to the EPF corpus. The employers also match this contribution. There is an option to increase employee contributions via VPF. Currently, EPF offers 8.15 percent interest, but interest on contributions above Rs 2.5 lakh per year is taxable.

The PPF is a similar small savings scheme, but it is open to everyone (unlike the EPF, which is open to employees only). Interest rates for PPF are reviewed quarterly. Currently, PPF offers 7.1 percent interest.

Given the sovereign guarantee and tax-free nature of both instruments, EPF and PPF should form the core of your debt portfolio. If you follow an asset allocation framework and your debt allocation is sufficiently managed via EPF and PPF, then you practically don’t need to look at other debt instruments. These two are enough.

So, you first exhaust your EPF contribution limit with the employer. If it's less than Rs 2.5 lakh in annual contribution, then use VPF to further increase your contribution. After that, consider exhausting the Rs 1.5 lakh tax-free limit of PPF.

Also read: Choosing between the VPF and PPF for additional debt investments

While EPF and PPF may be sufficient for some, they may fall short for many. So, if you need to invest more in debt, and since EPF is good but no longer fully tax-free (with interest on contributions above Rs 2.5 lakh taxable), only then do you need to consider other debt options.

Role of NPS (Scheme G + C) as pure debt

NPS is a retirement-dedicated product that allows investors to take exposure to both equity and debt and also control asset allocation. But unlike EPF and PPF, where the accumulated corpus at maturity is tax-free and allows unrestricted usage, NPS requires the mandatory purchase of an annuity worth a minimum of 40 percent of the accumulated NPS corpus. And the pension from this annuity is taxable. The remaining 60 percent is tax-free and available as a one-time lump sum payment. This mandatory annuitisation of savings makes NPS suitable only for a section of retirement savers.

But Scheme G (pure government securities) and Scheme C (corporate bonds) are debt-oriented and can be used to invest for debt exposure in retirement. And if your EPF and PPF corpus isn’t very large, you can use your NPS as a debt product with high allocations to schemes G and C to properly fit NPS in your retirement plan.

Also read: EPF or NPS: Which is the better investment option?

Are debt funds still good?

The recent removal of indexation benefits on debt fund taxation was a big blow for the category. But it is what it is. Given that all other debt products are now taxed mostly as per tax slab rates, if you are considering adding debt funds to your portfolio, then you need to be cautious about the type and category of fund you choose.

Debt funds can come in real handy when you have to rebalance your portfolio in both directions, i.e., from equities to debt in bull markets and vice versa in bear markets. This two-way rebalancing is difficult to achieve with illiquid debt instruments like EPF and PPF.

While picking debt funds for the long term, make sure you choose schemes across different categories to combine portfolios of different maturities. The categories can be a combination of Short Duration Funds, Dynamic Bond Funds, Banking & PSU Funds, Corporate Bond Funds, and Gilt/Constant Maturity Funds.

Disclaimer: This is just a broad discussion around the topic. Different investors have different risk appetites and time horizons. Do not consider the above discussion as investment advice in any manner. If you are a DIY investor, then please do your homework to figure out what the best equity allocation is for you. But if you have doubts, then talk to an investment advisor.