Should you still invest in PPF post the interest rate cut?

Adhil ShettyBankBazaar.comThe interest rate on PPF accounts has been set at 8.1% p.a. for the quarter ending June 2016 i.e. April 1st to June 30, 2016. This is a reduction from the previous rate of 8.7% p.a. (a reduction of 0.6%). Despite the rate cut, however, the Public Provident Fund Scheme (PPF), 1968 still remains an attractive investment tool for long-term savings and retirement planning. The reduction in PPF interest rates raised concern among investors about the effectiveness of the scheme in maximizing long-term returns. With rates set to be revised every quarter, in order to stay aligned with market rates, and a falling interest rate regime, investors wonder whether the PPF scheme cuts it in comparison to other investment avenues. The fear of PPF holdings losing its tax exempt status (EEE) also lingers on although the government has decided against this move. Why PPF still makes for good investingEven at 8.1% p.a. the PPF Scheme still offers attractive real rate returns. Considering inflation at 5.4% for Q2 2016, these accounts still offer returns that beat inflation. Historically, PPF has consistently managed to deliver attractive real returns even when inflation rates were on the rise. With inflation rates expected to hover around an average of 5% during the upcoming quarters of 2016 and a positive long-term inflation outlook, PPF rates continue to remain attractive from a long-term perspective. Interest earnings on PPF accounts remain tax-exempt and as such offer better returns than its most popular investment counterpart viz. bank FDs whose returns are diluted by tax charged thereon. Long-term bank fixed deposits offer returns in the range of 6% – 8% p.a. However, these are taxable. For depositors in a higher tax-bracket, this translates to considerably lower effective rates which don’t compare as favorably with PPF deposits. It is expected that with lowered rates on small savings schemes, banks will now be encouraged to reduce their deposit rates in order to accommodate lower lending rates. Tax benefits on PPF investments are also unrivalled by most other investment avenues. Besides the tax exemption on PPF interest earnings, investments in PPF accounts qualify for tax deductions U/S 80C and withdrawal at maturity is exempt from tax. The government has not indicated a strong desire to tax these savings in future post the recent roll back of its decision to do so in the face of stiff opposition. Even as the spread over benchmark rates for other small savings schemes has been removed e.g. with term deposits and Kisan Vikas Patra (KVP), PPF rates are still to be marked at 25 bps over its benchmark rates i.e. long-term government securities. The spread is higher for senior citizens at a 100 bps markup. Going ahead, PPF rates are to be reset every quarter. Even if rates are expected to reduce further, being aligned to market rates which are expected to fall, PPF investments retain their allure as long as their post-tax returns are higher than other similar products.PPF accounts are easily accessible through a large network of banks and post office branches all over the country with the option of online access as well. Opening and operating these accounts are convenient and simple making it easy to invest, creating a disciplined savings habit. Balancing PPF investmentsPPF rate cuts might be a call for investors to realign their investments but it does not spell the need for avoiding the scheme altogether nor for drastic departures from investing in it. PPF makes for a great investment for the risk-averse with limited funds and long-term savings plans. However, one should consider PPF not in isolation but as part of an investment mix; a portfolio that is balanced out by both fixed and variable return instruments. Investors should also bear in mind that the PPF scheme was designed to suit retirement planning. PPF deposits work for those with a 15 year timeline or more on savings. For younger investors, this should be supplemented by equity investments to maximize returns on their overall savings portfolio. In a falling interest rate regime, equity markets tend to perform better. PPF also works for the non-salaried who don’t benefit from EPF contributions. For older investors, PPF investments can be supplemented by other fixed-return, long-term investments like tax-free bonds or RBI bonds.