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Friday, May 22, 2015

Your EPF money will be invested in equity : Rebalance your portfolio

Not that you have any choice, but you should be aware that your corpus of Employee Provident Fund(EPF) (+VPF) which you have been accumulating over many years, is now going to be exposed to equity market. This move has its own merits and demerits. You must understand what's happening to your money, and you may also need to rebalance your portfolio to the extent of your money movement from a debt based investment (EPF) to equity based investment...read on...

Background
This has been a long standing move. Some financial analysts say that we are already 20 years late. Some feel that it is not wise to tweak the design of a fund which is designed for a safe and secure retirement. As we stand today, in all probabilities, this is now going to be a reality.

Options before the Finance Ministry
The Finance Ministry wants a small portion of the EPF corpus to be invested in stocks. Several options are being discussed in this regard
(1) One suggestion was for 1% of the estimated Rs 8,25,000 crore corpus of the EPF to be invested in stocks. That would mean an inflow of Rs 8,250 crore into the stock market.
(2) Another option is for 5% of incremental contributions to go into equities. This would mean an annual inflow of nearly Rs 3,500 crore into equities.
It is very likely that the second option would find favor, since that would be an ongoing annual injection into the equity market.

Impact of EPF money on Stock Market
Whichever option the government finally chooses, this may not really set the markets on fire. However, it will definitely have some impact on the overall returns of the 100% debt-based Provident Fund

What is the International Trend?
Globally, retirement funds are an important part of the economy. Tower Watson survey of 2015 indicates that seven large economies—Australia (51%), Canada (41%), Japan (33%), the US (44%), the UK (44%), the Netherlands (30%) and Switzerland (29%)—are investing a sizeable portion of their pension funds in the equity market. But these are all mature economies where returns from debt based investments is negligible at best.  Many pension funds have also gone bust after they put money in the stock market.

Merits of moving EPF money to Equity
  • NPS funds for central and state government employees, which invest 8-12% of their corpus in stocks, have outperformed the Provident Fund by a significant margin in the past five years. So, you can expect slightly better returns with equity being a part of EPF investment portfolio.
  • The current EPF return of 8.75% is not enough in these days of high costs. Equity exposure with all safeguards would generate higher returns in the long term
  • Most salaried employees have limited means to invest in stocks on their own, so EPF investing a small amount in equities will be good for them,
  • When the economy matures, interest rates of debt products will come down. Then you will have no option but to invest in equities to generate returns

Demerits of moving EPF money to Equity
  • The basic design of EPF was a stable long term corpus accumulation with decent returns. If someone was interested in high returns, there are always better investment tools like Mutual Funds and direct equity investments. Playing with the design of an investment tool is not something that is a very advisable move.
  • The investor (i.e. you) lose the freedom to decide whether you want to invest your money in equity or not. Your fixed money will be invested irrespective of your desires. You can only play a counter move to balance your portfolio by taking out an equivalent portion from your existing equity investments and moving them to debt, in case this move makes your portfolio skewed on to equity side.
  • The stock market is volatile, and one is never sure of the amount that one will actually get at the time of retirement. If the market is in a dull phase, there could be significant erosion of your equity component when you retire and money the most. Though the positive side is also true, but this volatility is what most investors fear - when it comes to retirement tools like EPF.

The fact is that you do not have a choice, unlike in other retirement and pension schemes like NPS, where you can chose the equity portion of your corpus (from 0% onwards). This forced equity investments seems to be a global trend primarily to bring positivity into the sagging equity market. Having said that, remember that if ever there was a long term debt based investment option which could be moved to equity, it has to be EPF.

Cheers

Manoj Arora
Freedom can buy you.... what money cannot !!

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