Will EPF investors earn higher returns due to increase in equity allocation?

Posted by: Arti Bhargava on Apr 17, 2017, 06.30 AM IST

Employees' Provident Fund (EPF) subscribers earn an annual return of 8.65%. The figure becomes much lower when adjusted for inflation. However, because of the government guarantee backing it and the tax-free nature of the instrument, EPF is a preferred long-term investing option for the salaried class.

Bank employee Sonali is excited about EPF allocating 5-15% to equities. Sonali feels a hike in equity allocation will mean higher returns for her investments, in turn meaning a higher retirement corpus. Is she right?

Provident fund remains the most widely used tool for retirement planning by salaried individuals. However, the idea that a higher allocation to equity will translate into higher returns may be somewhat misleading for subscribers like Sonali because the returns are pre-decided and announced by the government at the beginning of the financial year.

Therefore, they may not reflect the actual performance of the underlying portfolio. As of now, the rate seems to be following the downward movement in the market interest rates, down from 8.8% last year to 8.65% this year.

Over the last 2 years, since the allocation to equity was announced, the lower returns from debt do not seem to have been offset by higher equity returns.

This could also be explained by the fact that the equity allocation is applicable only on incremental flows and not on the entire EPF corpus till date.

As EPFO forayed into equity investing only two years ago, it is too soon to assess the impact of the hike in equity allocation. Right now the allocation is too small to make a telling difference to the annual returns.

Moreover, while 90% of the EPF is allocated to government securities, public and private sector bonds, only 10% is apportioned to the equity market. Even if good returns are achieved, its impact on overall returns from EPF would be minimal.

Further, the EPFO is not very transparent in terms of rate setting. So there is no way Sonali can predict or assess the impact of the allocation decision. Considering that Sonali is only 35, the allocation to equities is too small to give her a major reason to rejoice.

(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta) This article appeared in Economic Times dated Apr 17, 2017, 06.30 AM IST