This question was posed to us by a reader. So, let’s start by addressing the two instruments.
The Employees’ Provident Fund, or EPF, is a retirement fund for organised sector employees, managed by the Employees’ Provident Fund Organization, or EPFO.
Under the EPF scheme, a salaried employee pays 12% of basic salary (plus dearness allowance) every month, and an additional 12% is contributed by the employer. In total, 24% goes towards the EPF account. The interest rate is currently fixed at 8.5%.
The Public Provident Fund, or PPF, is a government-backed small-saving scheme. Though started in 1968 with the objective of providing social security during retirement to workers in the unorganized sector and for self-employed individuals, it has become a very popular tax-saving instrument. The interest rate is 7.1%; this is fixed every quarter.
Are these debt instruments?
A debt investment is one that offers a fixed return to the investor with a promise to repay the principal over a predetermined tenure. There are variations but this is the broad premise. Going by that definition, both the EPF and PPF are debt investments – an assured rate of return, and the principal will be returned over a predetermined tenure.
So yes, they are both part of the debt portfolio. BUT, they cannot be the only part of your portfolio. The reason being that both these investments have very long lock-in periods. They score on safety since they are both backed by the government. They have an assured return. But liquidity is not their strong point. The lock-in periods are long and premature withdrawals are applicable onlyfor specified and predetermined situations. To compensate, debt funds must form a part of your portfolio.
How should you decide which debt funds?
Keep the EPF and PPF as your base.
You can then select funds that are low on both, duration and credit risk. Do not deviate from this rule and you will avoid credit risk and interest rate risk. The advantage of such debt mutual funds is that investors get the benefit of lower tax rates (if held for > 3 years) and market returns. The appreciation in these funds is not only from the accrual of interest income, but possible capital appreciation due to interest rate movements.
Once you have the above in place, and you have cash to spare, then you can look for higher returns. But do not exceed 20% of your debt allocation to such funds. Here are some suggestions:
Gilt funds. These funds have no credit risk or risk of default. Their risk is interest rate movements. If you expect interest rates to dip in the future, you could consider a tactical bet here.
Dynamic bond funds can also be considered.
Credit risk funds can be opted for by a seasoned investor who is willing to take that extra risk.
My colleague Mohasin Athanikar of the Morningstar Investment Management team says that the fixed-income portion of the portfolio is predominantly focused on capital preservation and protecting the purchasing power of the invested corpus. He suggests treading cautiously and sticking to high-quality fixed-income investments as the core portion of the fixed-income allocation.
It’s a personal choice.
The type of funds you select will depend on your holding period and your understanding of their strategy.
A family member who does not understand debt funds only has money in EPF and PPF. On the other hand, a colleague told me that the PPF and fixed deposits have no place in his portfolio because the debt allocation is taken care of by debt mutual funds and EPF.
My debt portfolio comprises a fixed deposit, debt funds, as well as PPF and EPF. This includes my Emergency Fund.
Do you have an Emergency Fund?
To ensure that you do not tap into your portfolio during times of emergency, we strongly advocate that you have an Emergency Fund. Should you urgently need money, you may have to sell your equity investments which would be a problem if the market is at a low.
The Emergency Fund corpus must be at least six months of basic expenses. This can be part of your debt allocation. But when you use it, ensure that you replenish it.
Do read these two articles:
- Should debt funds be a part of the Emergency Fund
- 4 questions on Emergency Funds
