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Should You Invest In Small Savings Schemes?

Investors continue to be attracted to government-sponsored savings schemes due to their seeming safety and guaranteed returns. Here is what you should know about them

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Government” and “guaranteed” are two words that have forever enamoured domestic investors. It’s no surprise then that we continue flocking to small savings schemes distributed by the Post Office, despite a veritable inundation of non-traditional investment products ranging from mutual funds and ULIPs to structured products and portfolio management services.

Small savings schemes received a shot in the arm in the latter half of 2018, when the government effected rate hikes of up to 40 basis points across the gamut of available options. The question many investors are asking now is: should they take an exposure to them or give them the wide berth?

Adding another layer of complexity into the mix is the fact that rates on some of these small savings schemes are dynamically pegged to the yield on the 10-year G-Sec, and are revised quarterly. What this means is that you might start off at the current high rates of interest, but there’s no assurance that the rates will remain constantly elevated throughout the tenure of your investment! Bond yields were volatile in 2018; with rising benchmark interest rates, expectations of slower global growth and an unsteady outlook on oil prices dampening investor demand and widening spreads. A lot of these headwinds seem to be tapering off this year — with a stable rupee, benign CPI inflation, lower crude prices and RBI’s continued OMOs bringing down the 10-year yield by more than 30 basis points in the past month alone. It’s quite unlikely, then, that the presently elevated yields will sustain themselves for very long. All things considered, here’s a brief overview of five popular small savings schemes available today — along with our advice.

Public Provident Fund
The trustworthy old Public Provident Fund (PPF) continues to have its share of enthusiasts. And why not? PPF rates underwent a meaty hike from 7.6 per cent to 8 per cent in October 2018. Contributions to the PPF qualify for a tax deduction under Section 80C, and maturity proceeds are tax-free as well. Thus, the PPF falls under the “EEE” or “Exempt, Exempt, Exempt” category.

The PPF’s tax efficiency notwithstanding, it isn’t a “fixed return” product per se. Interest is computed on a monthly basis on the prevailing interest rate for that month, and compounded annually. So, don’t rush into the PPF in a bid to “lock in” the current rate of 8 per cent. It’s impossible to predict how G-Sec yields will move over the 15-year tenure of the PPF, and a sharp drop in bond yields can dent your PPF returns for that period.

Advice: PPF returns have traditionally been higher than other fixed income instruments such as fixed deposits, with a higher tax efficiency to boot. However, the lengthy investment tenure works against it. All things considered, it does make sense to couple a PPF investment with an ELSS (equity linked savings scheme) or an NPS (National Pension Scheme) investment to fill your Section 80C quota for the year. Your individual risk tolerance should determine your split ratio between the two products. Just make sure you make your PPF contributions before the 5th of every month, as you won’t earn any same-month interest on deposits made after the 5th!

National Savings Certificate
The National Savings Certificate or NSC as it is popularly called, is a simple, 5-year lock-in product in which the interest compounds annually. There’s no upper limit to the investment you can make, and the interest rate on your investment remains constant throughout. Your investment in NSC qualifies for a deduction under Section 80C, as does the annual interest — which is deemed as reinvested in that year. Simply put, you’ll receive approximately Rs 1.46 lakh in 2024 if you invest Rs 1 lakh in NSC today.

The only dampener in this otherwise competitive product is the tax-inefficiency. The accrued interest for every fiscal year is added to your taxable income and taxed at your marginal rate. This positions it unfavourably against other low risk fixed income products such as Fixed Maturity Plans, which allow for indexation benefits that bring in an additional layer of tax efficiency.

Advice: Locking in a high yield of 8 per cent for a 5-year period is a smart move. However, remember that your effective returns will be sub 6 per cent if you’re in the highest marginal tax slab. Go for the NSC if your annual income is less than Rs 10 lakh and you need to save taxes under Section 80C. If not, opt for FMPs from top mutual fund houses instead.

Kisan Vikas Patra
Somewhat similar in structure to NSC, Kisan Vikas Patra or KVP is a compounded-return product that “doubles” your money within a pre-set timeframe. Presently, KVP matures in nine years and four months, translating into an effective compound interest rate of 7.7 per cent per annum. Unlike NSC, contributions to KVP do not qualify for tax benefits, and the interest earned is added to your income in the year of maturity and taxed. The KVP allows for premature withdrawals after two and a half years, at six-month intervals thereafter. There is no ceiling limit to KVP investments.

Advice: Despite its allure as a purported “money doubler”, and notwithstanding the recent six-month improvement in its effective yield, KVP simply doesn’t make the cut as an effective investment product. If you wind up in the highest marginal tax bracket in the year of its maturity, your effective return will be just 5.4 per cent — barely good enough to beat the long-term inflation trend. Moreover, the nearly decade-long time horizon certainly entails a higher degree of risk taking. Investing into a well-diversified portfolio of conservative hybrid mutual funds will fetch far superior real returns with low risk; and with the benefit of indexation to boot.

Sukanya Samriddhi Yojana
Launched by the Ministry of Finance under the umbrella of the “Beti Bachao, Beti Padhao” campaign in 2015, The Sukanya Samriddhi Yojana (SSY) has become quite popular. The scheme itself is simple. You can open an account in your daughter’s name, provided she’s less than 10 years of age, by visiting the post office or a bank that offers the scheme (SBI, Allahabad Bank, ICICI Bank and HDFC Bank, to name a few). You can invest between Rs 250 and Rs 150,000 per year in the SSY account every year, and this amount is tax deductible under Section 80C. An online investment process was provided last year. Your SSY account will attract interest on the 10th of every month, and the moneys will be compounded annually. You’ll need to continue making the deposits for a period of 15 years, and the balance will continue to attract interest until the 21st year of your starting the account; at which point it will mature, tax-free. Alternatively, you may withdraw half the balance, if you so desire, for her higher education purposes when your daughter turns 18. The returns from this scheme are generally significantly higher than the yield on government bonds. Presently, it stands at 8.5 per cent.

Advice: SSY returns are now revised every quarter — in a falling interest rate scenario, this can hurt. Recall how SSY rates fell by 100 basis points between 2015 and 2018. Also, you’ll be earning fixed-income returns in a very long duration (21 year) investment. Do yourself a favour: ignore your risk profile when it comes to funding a long-term goal like your child’s education. Stick to SIPs (systematic investment plans) in small and mid cap funds. Over a 21-year period, this strategy will likely outpace an SSY account by 70 per cent or more.

Senior Citizen’s Saving Scheme
If you’re a senior citizen, the problem of generating a steady income stream from your investments would certainly be weighing heavily on your mind. The Senior Citizen’s Saving Scheme or SCSS, which is open to all investors over 60 years of age, attempts to solve the issue partially. SCSS returns, albeit taxable, tend to be a 100 basis points higher than prevailing government bond yield. An additional silver lining is the fact that interest incomes of up to Rs 50,000 received from this scheme are deductible under Section 80TTB, and investments made into SCSS qualify for deductions under Section 80C as well. Investors are allowed to invest a maximum amount of Rs 15 lakh in SCSS, which would yield a quarterly income of Rs 32,625. Once locked in at the start of the scheme, the interest rate remains constant for the next 5 years, which is a plus point in high interest rate scenarios such as today’s.

Advice: SCSS offers a really good risk-free return of 8.7 per cent at the moment. Factoring in the 80TTB deduction, this would work out to a post-tax yield of more than 7 per cent for a senior citizen in even the highest marginal tax bracket. The only drawback is the low ceiling of Rs 15 lakh, which translates to a maximum monthly income of a mere Rs 10,875 before taxes. But if you’re more than 60 years old, and its steady income you’re after, it certainly makes sense to max out your SCSS quota.