I heard of PPF (Public Provident Fund) accounts in my thirties. That's sad in a way, but good in another way. I'll explain.
We have seen in our earlier post on Asset Allocation , that Fixed deposits and safe instruments are an essential part of any investor's portfolio.
PPF is a safe (backed by the Govt. of India), but long term investment, not suited for short-term. But a quick primer on PPF first:
The Public Provident Fund was established by the central government. Any Indian citizen can open one. You don't have to be a salaried individual, you could be a consultant, contractor or non-earner also.
Any individual can open a PPF account in any nationalized bank or its branches that handle PPF accounts. You can also open it at the head post office or certain select post offices.Note that Private banks can't help you with this account.
The minimum amount to be deposited in this account is Rs 500 per year. The maximum amount you can deposit every year is Rs 70,000.
The Interest rate is 8% compounded annually. The accumulated sum is payable to you after 15 years.
The entire balance can be withdrawn on maturity, that is, after 15 years of the close of the financial year in which you opened the account.
It can be extended for a period of five years after that. During these five years, you earn the rate of interest and can also make fresh deposits. The amount you invest is eligible for deduction under the Rs 1,00,000 limit of Section 80C.
On maturity, you pay absolutely no tax. There are some provisions to withdraw up to 25% of your deposits starting the 3rd year, but I'll leave for you to do the research.
In my mind, whether or not you are a risk averse investor, you should have this in your portfolio, and max it out also.
You should ideally invest the max. amount i.e. Rs. 70,000/- every year by April 1st week to get the maximum interest benefits and tax savings. Note that this account is a once in life time opportunity for all individuals .You can't open multiple PPFs in your name at multiple banks.
Hence it is better to be aware of this account, but open it when your earnings are such that you can max out Rs. 70,000/- every year (as otherwise, you may not realize the full interest and tax savings). Which is why, I don't regret knowing about it in my 30s.
I sat down to do the math and came out with the following calculations that explains how your money grows (picture below).
The power of compound interest is evident with the passage of time. Just observe the interest column (every year).
In the initial years the interest is somewhat low, but towards the end of the maturity period, you get more annual interest than even your payments
For example, in year 10, you pay Rs. 70,000 but you accumulate Rs. 81,125 in interest. In year 15, you nearly earn Rs 1.5 Lakhs in interest itself. Bear in mind, it attracts 0% taxes. Hence the effective yield is nearly 12%. So much for the snowball effect.
A smart strategy is to open up a 1 year RD A/C in the prior year and invest Rs. 5,833 every month. At the end of 12 months, your RD will mature to give you Rs. 70,000 + some interest. You can use Rs. 70,000 for the subsequent year's PPF deposit, and the interest for something that you want for yourself. If you make the monthly RD Payment as an automatic deduction from your salary account on your pay day, you won't even notice the difference.
Imagine receiving a lump sum of Rs. 20.5 Lakhs tax free after 15 years. Isn't it exciting?
Note that these calculations assume that you systematically invest Rs. 70,000/- every year at the beginning of April . If you make lower yearly contributions or make them at a later time period (than in April itself), then the interests and maturity amount will vary (to a lower amount) correspondingly.
Aren't you headed to the nearest SBI or postoffice yet?
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