This is part II of the article Retirement Planning & Long Term Investment Management – Part I. Please start reading from the first part before proceeding with this one.
I’ve worked a lot on models and investment return predictions. Researchers across the globe keep making models and predictions about the behaviour of stock prices in the next 5 or 10 year horizon. When asked to change the horizon by just 1 year, from 10 years to 11 years, the model shows a completely different trend. It’s only that we can talk about historical values and make our claims and predictions. What we ignore is the fact that history may not repeat itself. Forget about the common man, even financial experts and fund managers with decades of experience could not predict the stock market behaviour from 2001 to 2004, as explained in my previous post Do equities give better returns in the long run?
I’ve always advised people to invest with a PURPOSE. When retirement planning is the purpose, we should realize that retirement is certain. Hence we should aim for certainty in our investment for a certain purpose. Taking uncertain risks in the stock market for a certain purpose can be very costly.
Assume that you are 28 years old and are planning to invest for your retirement at 58 years You have 30 year long horizon.
Have a look at the following table for a mere 10,000 Rs. investment in PPF for 30 years.
| | | | PPF Interest | 8.50% | |
| | a = c + e | b | c = 30% of b | d = a + b | e = 8.5% on d |
| Year | Previous Year Carryforward + Tax Benefit | Annual Investment | Tax Benefit-30% | Total Annual Investment | After earning interest |
| 1 | - | 10,000.00 | 3,000.00 | 10,000.00 | 10,850.00 |
| 2 | 13,850.00 | 10,000.00 | 3,000.00 | 23,850.00 | 25,877.25 |
| 3 | 28,877.25 | 10,000.00 | 3,000.00 | 38,877.25 | 42,181.82 |
| 4 | 45,181.82 | 10,000.00 | 3,000.00 | 55,181.82 | 59,872.27 |
| 5 | 62,872.27 | 10,000.00 | 3,000.00 | 72,872.27 | 79,066.41 |
| 6 | 82,066.41 | 10,000.00 | 3,000.00 | 92,066.41 | 99,892.06 |
| 7 | 102,892.06 | 10,000.00 | 3,000.00 | 112,892.06 | 122,487.88 |
| 8 | 125,487.88 | 10,000.00 | 3,000.00 | 135,487.88 | 147,004.35 |
| 9 | 150,004.35 | 10,000.00 | 3,000.00 | 160,004.35 | 173,604.72 |
| 10 | 176,604.72 | 10,000.00 | 3,000.00 | 186,604.72 | 202,466.13 |
| 11 | 205,466.13 | 10,000.00 | 3,000.00 | 215,466.13 | 233,780.75 |
| 12 | 236,780.75 | 10,000.00 | 3,000.00 | 246,780.75 | 267,757.11 |
| 13 | 270,757.11 | 10,000.00 | 3,000.00 | 280,757.11 | 304,621.46 |
| 14 | 307,621.46 | 10,000.00 | 3,000.00 | 317,621.46 | 344,619.29 |
| 15 | 347,619.29 | 10,000.00 | 3,000.00 | 357,619.29 | 388,016.93 |
| 16 | 391,016.93 | 10,000.00 | 3,000.00 | 401,016.93 | 435,103.37 |
| 17 | 438,103.37 | 10,000.00 | 3,000.00 | 448,103.37 | 486,192.15 |
| 18 | 489,192.15 | 10,000.00 | 3,000.00 | 499,192.15 | 541,623.49 |
| 19 | 544,623.49 | 10,000.00 | 3,000.00 | 554,623.49 | 601,766.48 |
| 20 | 604,766.48 | 10,000.00 | 3,000.00 | 614,766.48 | 667,021.63 |
| 21 | 670,021.63 | 10,000.00 | 3,000.00 | 680,021.63 | 737,823.47 |
| 22 | 740,823.47 | 10,000.00 | 3,000.00 | 750,823.47 | 814,643.47 |
| 23 | 817,643.47 | 10,000.00 | 3,000.00 | 827,643.47 | 897,993.16 |
| 24 | 900,993.16 | 10,000.00 | 3,000.00 | 910,993.16 | 988,427.58 |
| 25 | 991,427.58 | 10,000.00 | 3,000.00 | 1,001,427.58 | 1,086,548.93 |
| 26 | 1,089,548.93 | 10,000.00 | 3,000.00 | 1,099,548.93 | 1,193,010.58 |
| 27 | 1,196,010.58 | 10,000.00 | 3,000.00 | 1,206,010.58 | 1,308,521.48 |
| 28 | 1,311,521.48 | 10,000.00 | 3,000.00 | 1,321,521.48 | 1,433,850.81 |
| 29 | 1,436,850.81 | 10,000.00 | 3,000.00 | 1,446,850.81 | 1,569,833.13 |
| 30 | 1,572,833.13 | 10,000.00 | 3,000.00 | 1,582,833.13 | 1,717,373.94 |
| | Total Investment | 300,000.00 | | | |
Taking tax benefit into consideration, a simple investment of 10,000 Rs a year translates into more than 17 lakhs, while you invest a total of 3 lakh Rs. only. That too, it’s RISK FREE and certain investment. The only risk is that interest offered by PPF may come down. Thanks to the Leftist political parties, the government is forced to keep the interest rate at 8.5%.
5 comments:
Hi Shobhit,
Your articles are pretty nice and very informative. A lot of the things mentioned (esp about equities etc) are what I used to have debates about with my friends in b-school. But seeing these on your blog makes me feel you're reading my mind :)
However, this article is a bit confusing. A PPF account is valid for 15 yrs and can be extended for 5 years more. However, after 20 yrs, one should close the account and open a new one. From then on the annual limit applies - Rs 70 k max per annum.
In this scenario the 30 yr projection you gave wont be valid. Besides, how is the tax benefit carrying forward? Is there another investment for that?
I might be mistaken, but could you please double check?
Hi Manu,
A recent development concerning PPF has come to my notice. The time limit for PPF has been increased upto 30 years. You may want to confirm this from the bank regarding this.
Cheers,
Sourabh
one can extend the PPF account to as many times as one desires in blocks of 5 years. The amount which can be withdrawn in any one extended block is limited to 50% of the balance at the point of extension. But, deposit is limited to 70000 annually. The entire amount is TAX FREE and also WEALTHTAX FREE.
Hi Shobit,
This is a good article showing importance about PPF and start using PPF account regularly, earlier in life and for a longer duration.
However, I feel that, there is a small mistake in the benifits you have calculated.
Tax benifit of 3000, we get everyear on investment of 10000. but that is only one time benifit. You have include that in your principal which is going to get the interest.
Tax benifit of 3000 helps you to keep your 10000 as 10000 and not 7000. but it does not make your 10000 to 13000.
Due to that, total earnings after 30 years will come around 1347730.
Please correct me, if i am wrong.
Thanks,
Bhavik.
Bhavik,
There is no mistake in the calculations. The tax-benefit is ploughed back into the investment as indicated in column a.
Thanks,
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