PPF investment can beat Sensex returns over 20-year period - it can, but it did not this time ...

There are so many instances when you come across a newspaper article and the heading itself tells you that there is something wrong with the story. Recently, one such story talked about equity underperforming PPF over a 20-year period. As a proxy of equity, the writer had taken Sensex data. This story was published in a leading business daily and has been widely circulated in social media.

First of all, the timing of the story is interesting. The author highlights this in the opening paragraph. The line catches attention. It stresses upon the fact that in spite of the last 40% upside, equity underperforms PPF. Well, those who understand compounding know that 40% for a year is lower than 8% per year for 10 years and far lower than 9% per year for 20 years.

Secondly, the writer has picked up one period (just one period) to prove a point. Anyone with an understanding of statistics knows that this is too small a sample to be called representative of anything. (For more detail, please see this story … http://www.cafemutual.com/News/Don’t-be-fooled-by-averages~124~Cli~FinancialPlanning~61)

One must question why only this period is picked up for the analysis. Is this some kind of a Bollywood movie script that one is talking about “Bees saal pehle ki baat hai…”? Exactly 20 years ago, the Sensex was at a high point. While the writer mentions the 40% upside in the last one-year of the analysis, he forgot to mention a similar rally between August 1993 and August 1994. Well, that rally was not similar to the current one. Here are the numbers:

Month	Sensex closing value	One year change
August 1993	2,633.79	74.20%
August 1994	4,588.16

Month	Sensex closing value	One year change
August 2013	18,619.72	42.02%
August 2014	26,442.81

While the Sensex has gone up by 42% in the last year, it had gone up by 74% for the year at the start of this analysis. This means, it is not just the current point that is high as mentioned by the writer, even the starting point of his analysis was also a high point.

Third, PPF cannot have a one-time investment. It requires annual investment. This will completely change the result if you allow annual investments both in PPF as well as equity. Those familiar with the concept of SIP in equity would understand this point.

Fourth, and very important – the writer does not seem to know much about the index used. Sensex, the index he has used to represent equity is a principal return index and not a total return index.

A principal return index reflects the movement of the stock prices and ignores any dividends paid out along the way. A total return index adds back the dividends also.

Why are we suggesting that this is a critical point? The writer has considered reinvestment of all the interest in case of PPF and hence got the benefit of compounding. To do a fair comparison, even the equity dividend should also be considered reinvested.

We constructed a hypothetical index assuming various dividend yields and added back all the dividends. We used Sensex data as the base for the calculations and assumed three different dividend yields (annualized), viz. 1.0%, 1.5% and 2.0%. We had to do this since Sensex Total Return Index is not publicly available on www.bseindia.com. 

Our data is marginally different since we have taken August data till 25^th August, whereas the writer of the article might have taken slightly old data. However, this difference is so small that it may be ignored. (According to the article referred, Sensex was up 5.75 times over 20 years, whereas in our analysis, Sensex is up 5.76 times). Investment in PPF, on the other hand, would have multiplied by 7.31 times – quite a difference this is.

According to the said article, investment of Rs. 10,000 in PPF would be worth Rs. 73,124. In comparison, investment in Sensex for the same amount would be worth Rs. 57,520.

As mentioned earlier, this number is calculated without adding back the dividends. What happens if we add back the dividends?

Here is the data (as calculated by us):

Amount invested: Rs. 10,000 (one time investment)

Investment period: 20 years

Value after 20 years:

Investment vehicle		Value after 20 years	CAGR
PPF		Rs. 73,124	10.45% p.a.
Sensex	Without dividends	Rs. 57,633	9.15% p.a.
	Dividend yield of 1% p.a.	Rs. 70,387	10.24% p.a.
	Dividend yield of 1.5% p.a.	Rs. 77,841	10.79% p.a.
	Dividend yield of 2% p.a.	Rs. 85,949	11.35% p.a.

Over the years, the average dividend yield on Sensex stocks has been in the range of 1.5% p.a. to 2% p.a. In both these situations, the final value of equity investment is higher than PPF.

Having said that, our attempt is not to prove that equity would always outperform PPF for periods as long as 20 years, since we have also presented only one data point. The idea is not to prove equity as superior to anything else, but to highlight the fact that if some part of the data is ignored, a totally different picture may emerge. Equity is a risky asset class and hence one should not expect 100% guarantee of positive returns, whatever the period.

Let us revisit the title, "PPF investment can beat Sensex returns over 20-year period" - can it happen? Yes, as mentioned in the previous paragraph, equity is a risky investment avenue. The risk may result into underperformance or negative returns. However, in this analysis, it did not happen.

PPF investment can beat Sensex returns over 20-year period - it can, but not this time ... 

What are liquid funds?

My article explaining liquid funds in Mid-day Gujarati today:

Understanding liquid funds

The English translation is given below:

According to a lot of people, all mutual funds are equity funds. One of the reasons behind this myth is the regular risk line that appears in all mutual fund communications, “Mutual fund investments are subject to market risk.” The words “market risk” have a very strong association with equity. So many investors have heard of equity markets, very few know about debt markets or money markets.

This is why not many know of the largest category among mutual funds – the liquid funds. This is a category of funds that helps one park money for very short periods.

If you are running your own business, there are periods when some surplus may be lying in your current account with the bank. This may be shifted to a liquid fund. So let us understand what liquid funds are and how these work.

Liquid funds invest in debentures with very short maturity. Earlier, these liquid funds used to invest in debentures with maturity less than 18 months to 2 years, with average maturity of less than 6 months. However, according to recent SEBI guidelines, liquid funds can invest in instruments with maturity not exceeding 90 days. Such guidelines only ensure that when the investor is looking at a liquid fund with a very short term view, the underlying investments also should be of short maturity.

What does the above mean to an investor? Well, an investor who needs to invest money for a period as short as 2 days can consider liquid funds. The liquid fund offers higher returns than interest paid on the savings account with instant liquidity and high safety of capital. Ever since liquid funds came into existence more than a decade back, there have been only two instances when the NAV (NAV of a mutual fund is the realisable market value of units) of some of the liquid funds were lower than the previous day. This shows us how low is the probability of losing money in liquid funds even for a single day. One must remember that the decade has been marked with certain periods of crisis never before witnessed by the present generation.

What are some of the applications of these liquid funds?

For starters, any money lying idle in a bank account for more than a week should be put in a liquid fund. I know of a friend, very money savvy, who used to purchase his monthly household items using his credit card, while simultaneously putting equivalent amount of money in a liquid fund to be withdrawn couple of days before the credit card bill payment date. This allowed him to earn even on the money he had spent. However, one must be very careful with such a strategy as missing the date with the credit card could be a lot costlier than what one can earn through the liquid funds.

Another application of liquid funds is ideal for businesses – be it small or large. In businesses, the cash flows are highly uncertain and hence periodically the business may end up with huge surplus. Such money can be invested in a liquid fund as it allows the flexibility to invest money for period as short as two days to as long as forever. When one is not certain when the money would be needed, liquid funds are the ideal choice.

Large companies with surplus cash also invest idle money in liquid funds, which is withdrawn when there is a need for capital investment, acquisition, business expansion, etc.

In the heydays of IPOs (Initial Public Offering) by companies raising money from the stock markets, many investors used to roll the money over from one IPO to another, either the money received as refund or the realisation on sale of shares on listing. The money lying idle between such opportunities was parked in liquid funds.

As mentioned earlier, liquid funds offer marginally higher return compared to savings bank account with high degree of safety.

Please remember that investment in liquid fund is all about convenience rather than returns. Your primary need is to get money when you need. Over last few years, mutual fund companies have introduced certain innovative practices to make it even more convenient. We have a facility to transact in liquid funds with the help of SMS or Internet. Some funds offer a debit card facility along with your liquid fund account. You may go to a bank ATM and withdraw money as required directly from your liquid fund account.

Choose a mutual fund advisor who can help you with multiple transactions in liquid funds. Check with one before you start the relationship.

You need not spread your money across many funds, one may be enough.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Be ready for volatility if you want to invest in equity - English translation of one of my old articles

શેરબજારમાં રોકાણ કરવું હોય તો ઊથલપાથલ માટે તૈયારી રાખવી

The above article was published in Mumbai Samachar in December 2011. Please remember, this was written in December 2011 and not in August 2014.

Below please find the English translation of the same article:

The other day I received a call from a friend, who was concerned about the falling value of his investments – particularly his equity investments. He inquired whether he should stay invested in equity mutual funds and whether he should continue his SIPs in those funds, when the portfolio value was down even after holding period of over 3 years.

He insisted that he needed the money for some expenses that have come up suddenly.  In such a case, there is no argument and one has to take money out of investments to fund the expenses.

While we were having the discussion further, he asked if he could consider investment in PPF or NSC. I suggested that these are good options but one has to consider the liquidity requirement as these instruments have limited liquidity. He wanted to invest in these debt instruments and mentioned that he had no liquidity requirement. He was ok locking the money for some time.

Now, see the thread between the above paragraphs. Sudden liquidity requirement comes up when equity portfolio goes down, but the same investor has no need for liquidity and is willing to lock money for years.

The fact is, in this it was not liquidity but the concern that was driving the decisions.

Watching the portfolio value going down is always painful for anyone. However, a decision should not be taken because of the pain, but only after a careful analysis and understanding of the situation.

Try to understand your financial condition. Answers to a few questions would suggest if you are in a position to take risks of investing in equity markets. The questions that would help you assess the situation are:

·       Do you have a regular cash flow to fund your regular expenses?

o   Such cash flow could come through your professional income or salary or through investments in form of dividend, interest or rentals or it could be in form of loan, e.g. reverse mortgage

o   How regular and sustainable is this cash flow?

·       In case the above cash flow stops, what is the contingency arrangement?

·       Have you provided for repayment of your outstanding loans and other liabilities?

·       Do you have enough health and life insurance?

·       Can you live your life comfortably without touching the amount set aside for equity investments? If you are going to need this money in the next five to seven years, be more careful.

Equity investments are subject to market fluctuations and hence a small investor must be careful investing in equity. At the same time, in order to create wealth over long period, this is one vehicle that an investor cannot ignore.

Happy investing

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Views expressed here are his personal views. He can be reached at amit@karmayog-knowledge.com.