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Why PPF is Not a Risk Free Investment?

BY: Vivek SHARMA | Category: Finance | Submitted: 2012-02-12 07:25:45
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Article Summary: "Understand the key risks in Public Provident Fund Investment..."

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Public Provident Fund (PPF) is a very popular investment option for salaried individuals. People use PPF as a tax saving tool. Under Section 80C of Income Tax act in India, you can make investments upto Rs. 1 lakh in PPF and get tax benefit of 30.9% if you are in highest tax slab. Another attraction of PPF is that it is exempt from tax totally and is often classified as EEE i.e Exempt at the time of investment, exempt when interest gets accrued on investment and exempt at the time of withdrawal.

People feel that investment in PPF is very safe as it a Government of India (GOI) scheme. The perception is correct as well because likely of default on payment of principal and interest accrued is just unthinkable. However, it is equally important to note is the fact that PPF as an investment option has two risk element. They are called as interest rate risk and reinvestment risk. When you invest in PPF, the account is opened for 15 years. Imagine that you open an account today; you will expect PPF account to pay 8.6% percent interest for next 15 years. It may so happen that by 5th year the rate of interest changes to 8%. This means that all your future interest earnings and re-investment income will be at new rate of interest. This will reduce future cash flow and hence the maturity amount of PPF investment.

In finance, the risk of an investment is generally evaluated on the basis 1) Default Risk and 2) Re-investment Risk. Though there is no default risk in PPF, re-investment risk does exist in PPF. So next time when you invest your money in PPF, be sure that you have not selected a truly risk free investment

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