PPF: Why Timing Is Important

While investing in PPF, investors must remember to put in the money at the right time to maximise the return they earn from it.

Illustration: Uttam Ghosh/Rediff.com

A Public Provident Fund (PPF) investment offers a tax-free return of 7.1 per cent.

Among government-backed fixed-income schemes, only Employee's Provident Fund (or EPF, which gives 8.1 per cent) and Sukanya Samriddhi Yojana (SSY, which gives 7.6 per cent) offer higher tax-free returns.

One significant point investors must remember while investing in PPF is that they must put in the money at the right time to maximise the return they earn from it.

How interest is calculated

An investor can deposit up to Rs 1.5 lakh in a PPF account each financial year. The minimum one can invest is Rs 500 per month.

Dilshad Billimoria, board member, Association of Registered Investment Advisors, says, "Interest on PPF is earned on a monthly basis, but credited to the PPF account at the end of the year."

Interest is calculated on the lowest balance between the 5th and the end of each month.

Adhil Shetty, CEO, Bankbazaar says, "Deposit your contribution on or before the 5th of the month so that it earns interest for that month."

If you invest after the 5th, that tranche of your investment will not earn interest as it will be calculated on it only from the next month.

Don't lose out by investing late

Gaurav Aggarwal, senior director, Paisabazaar.com says, "The best time to invest in PPF is at the start of a financial year. This way the investor can earn interest on the deposit for the entire year."

Suppose that your PPF account balance on March 31, 2021 was Rs 15 lakh.

You invest the maximum permitted amount of Rs 1.5 lakh as a fresh contribution on April 3.

Your PPF balance on April 3 becomes Rs 16.5 lakh. The minimum balance between April 5 and April 30 also stands at Rs 16.5 lakh.

So, for the month of April, your account will earn interest at the rate of 7.1 per cent on Rs 16.5 lakh, which equals Rs 9,762.

Now, suppose that you make the same contribution on April 7.

The minimum balance between April 5 and April 30 in this case will be Rs 15 lakh.

The interest earned on this amount will be Rs 8,875.

Just by delaying contribution to the PPF account by a few days, you lose out on interest income of Rs 888 for the month.

This difference may seem small. However, PPF is a 15-year instrument that can be extended further.

The compounding effect over such a long period means you would lose a considerable amount due to this small mistake.

Aggarwal says, "Even if you invest in PPF in tranches, do so by the 5th of the month to earn maximum interest."

Safe instrument, high return

Even in long-term portfolios, such as retirement, you need to have a fixed-income component of at least 20 per cent or more for stability.

This part of the portfolio should be constituted using instruments like EPF and PPF.

EPF contribution of only up to Rs 2.5 lakh is tax free.

Contribution above this amount is taxable at slab rate.

The tax-free return from SSY is only available to people who have a girl child.

For the self-employed, who do not have access to EPF, PPF becomes even more crucial.

PPF's tenure can be extended. Billimoria says, "Investors can extend PPF for as long as they like in blocks of five years. We recommend doing so. All extensions have a lock-in period of five years only."

While PPF can help you save tax and invest systematically for retirement and other long-term goals, you cannot rely on it alone.

"The interest rate of 7.1 per cent beats inflation by barely about one percentage point. This rate of return is not sufficient for building a hefty corpus," says Shetty.

When your investment horizon is seven years or more, have a considerable allocation to equities.