Public Provident Fund – or PPF can be a wonderful instrument to get assured, long term and tax free returns. And as we can see subsequently see in this article, PPF can help your money grow and compound in quite an amazing way.
(Related article – Should you invest in PPF? )
PPF falls under EEE (Exempt Exempt Exempt) category –
Your contribution to PPF is eligible to tax exemption under Section 80C. The principal amount on withdrawal is exempt from tax. And the interest you earn is also exempt from tax. So, tax exemptions along with a reasonably high interest rate (usually higher than fixed deposits) make PPF an attractive investment option among people of India.
While historically, equities have given better returns, it is important to consider both capital growth and capital protection for your long term financial goals, especially if you are a typical middle class Indian household, where a major downside in any asset class you own may severely impact your returns. E.g. If a major crash happens in equities, and you are not adequately diversified you may see sizable capital erosion.
(Also read- PPF versus ELSS – Which is a better investment )
How much money can you make if you invest maximum permissible amount in PPF every year?
Currently, PPF has an interest rate of 8% per annum, This is calculated monthly and credited to your bank account annually.
Suppose you invest Rs. 150,000 (maximum permissible limit currently) in PPF every year, at the beginning of the financial year, and continue to to do so for several years, the balance at the end of each year can be summarized below. In table 1, I have assumed 8% interest rate. In table 2, I have assumed a more conservative 7.5 % interest rate. (I believe that in long run, the interest rates may reduce.)
(Please note that for the sake of simplicity, I have consider annual compounding. Actually compounding will be done monthly, and hence returns may be marginally higher)
Table 1 – PPF Balance at 8% Per year interest if you contribute Rs. 150,000 each year, at the beginning of the year
Table 2 – PPF Balance at 7.5% Per year interest if you contribute Rs. 150,000 each year, at the beginning of the year
For initial few years, you can notice some interest credit which may not be too huge. However, in subsequent years, the interest increased dramatically & you can see the power of compounding kick in. At around 10 year mark (in both cases) the interest contribution to your balance surpasses the principal contribution.
At around 24th year mark, you can see your balance touching the much haloed Rs. 10,000,000 (1 Crore) mark. So, at that point of time you would have become a PPF crorepati! (Of course, the cost of living would have risen by then, but it is still quite a good number. Isn’t it?) This process can be accelerated if the government increases the limit on the amount you can invest in PPF every year or if the interest rates rise.
Now that you have seen the power of compounding in PPF. should you invest in PPF?
I would suggest yes, given that it gives a risk free & tax free returns, usually higher than most fixed returns instruments.
PPF may or may not be able to match equities in long run, but then, capital protection is also an important part of your investment strategy, and PPF can be handy tool for that. (and give decent returns too – few percentage points more than inflation)
(Note – Please read about the PPF rules, especially lock in period, extension of account and withdrawal rules)