Maximizing Employee's Contribution to PF
To do or Not to
do?
A couple of days
back, a friend told me about his young IITian son’s first job. In the course of
his conversation, he mentioned that he had advised his son to go in for
“maximizing” the “Employee’s contribution to Provident Fund” so as to build an
“automatic savings corpus” right away.
I did proffer my
opinion about the same in brief – that it may not necessarily be a great idea
if the individual concerned happens to be a thrifty individual and has adequate
self-discipline, especially in matters pertaining to personal finances. During
the course of the weekend that followed, I thought further about it. And here
are a few of my thoughts:
Considering the
temptation to blow up one’s “newly acquired monthly inflows”, it is indeed a
good idea to send away a part of the money “automatically” into the savings
pool before it reaches one’s hand. This is certainly true for the vast majority
of youth today. Even more so if the young kid satisfies one (or both) of the
following two conditions:
From anecdotal
evidence, I would guess that at least one of the above two conditions will
apply to well over 95% of people entering the corporate world today. My mom
(and people of her generation) would be tempted to say that the figure ought to
be 99.99% J!
What about the folks
who don’t satisfy even one of the above two conditions? They will be under
immense pressure from their parents, friends, colleagues and perhaps even some
so-called financial experts to maximize the “Employee’s contribution to PF”. The
logic would broadly be as follows:
“You’re earning quite
a bit considering your life-style – Obviously you will be able to save this sum
without even noticing it”
“The power of
compounding works like magic – Before you realize, this contribution would have
grown immensely”
“If you don’t save
this money, you will spend it or lend it or give it or otherwise fritter it
away”
At a superficial
level, the logic is quite appealing. But I’m not convinced. In fact, I would
strongly urge such an individual to ignore the logic and contribute the MINIMUM
possible amount to the “Employee’s quota” of PF Contributions.
Here are a few
reasons:
Being
self-disciplined and financially thrifty, he will in any case save enough of
his money on his own – He doesn’t HAVE TO maximize his contribution to PF.
In any case, the
Provident Fund fetches a ridiculous sub-10% returns on the savings. This doesn’t
in any way cover the real inflation rate that will be applicable to an upper
middle class individual.
More importantly,
considering the long-term horizon for this individual’s savings, he ought to
look at maximizing returns, rather than safety. In fact, the past track record
of the past 10, 20, 30, 40 and 50 years would confirm that returns of
systematic monthly recurring investments equity shares / equity mutual funds
have consistently and significantly outperformed any fixed income products like
Bank deposits, Provident fund, NSC, etc. Hence, risk becomes almost a
non-issue.
The same logic would perhaps hold true for investments in real
estate as well.
Hence, I re-emphasize
my initial point:
Instead, you MUST do
the following:
Shift any surplus
funds over and above your typical monthly expenditure into a highly rated
liquid mutual fund.
From the balance in
this liquid fund, build a corpus of perhaps 3-6 months of monthly expenses (not
monthly income) and park it in a carefully chosen short term debt fund.
Identify your real
insurance requirements (Typically you will require a Term Insurance Plan to
cover your life, a health insurance plan and perhaps an Accident Insurance
plan) – Explore the possibility of taking adequate insurance cover for all
these requirements.
Once this “Emergency
Fund” corpus as well as your Insurance needs are both “ready and done”,
identify 3-5 high quality equity oriented mutual funds and start a Systematic
Investment Plan to invest your routine monthly surplus to these equity oriented
mutual funds.
Stay on the look out
to buy your own home For Living – As and when you
identify a suitable property, you may wish to consider taking a suitable
housing loan and buying that property.
Watch out for the
launch of high quality Real Estate Investment Trust products (REITS). SEBI and
the FM have just approved the concept. I’m sure that reliable and trustworthy
players like HDFC, Tatas, Birlas, TVS Group, SBI, L & T, etc. will very
soon come up with their own REITS. Considering the fact that under the
proposal, long term capital gains from REITs (units which are held for over 12
months) are likely to be completely exempt from Income Tax, REITs are bound to
be hugely popular investment avenues for those who wish to park their funds in
Real Estate for investment purposes. (To put things in perspective, if you sell
a house that you have been living in for the past few years, your capital gains
will be completely taxable, whereas, a corresponding investment in REITs would
be tax-free).
In a nutshell,
remember that unlike your spendthrift friends who blow up their money, you are
disciplined and thrifty. Hence, make the most of it and kill the monster of
inflation with your hard-earned savings. Saving money is just the first step.
The next key step is to convert your savings into investments.
This, I’m sure, will
not only make you immensely wealthy over the next couple of decades, but will
also ensure that you will be able to become financially free by the time you
hit 40.
Don’t waste your money by maximizing your contribution to
PF!
Regards,
N
