PPF v/s FD: Don't let biases drain your savings
What's the story
Indian investors frequently grapple with the choice between Public Provident Fund (PPF) and Fixed Deposits (FDs) when it comes to saving money.
While both options have their advantages, cognitive biases can play a huge role in decision-making.
Recognizing these biases can empower investors to make smarter decisions that truly align with their financial objectives.
Familiarity
The familiarity bias trap
Most investors prefer Fixed Deposits because they are more familiar and easy to understand.
Banks have been pushing FDs for years, making them the default choice for most people looking to save.
This bias toward the familiar causes many to miss out on the benefits of PPF, including its significant tax-saving advantage under Section 80C of the Income Tax Act, which permits deductions up to ₹1.5 lakh per year.
Recency
The recency effect influence
The recency effect occurs when an investor's decision-making is influenced by recent events or experiences.
For example, a recent reduction in Public Provident Fund rates may cause an investor to perceive fixed deposits as more favorable, despite the long-term historical performance and tax advantages of Public Provident Fund.
This recency bias can distort the investor's perspective, leading to decisions that may not align with their long-term interests.
Liquidity
Overestimating liquidity needs
Investors frequently overvalue liquidity and select FDs because they can withdraw money from it easily.
Sure, FDs provide superior liquidity compared to PPF accounts with a 15-year lock-in period, but this bias can result in forgoing the significantly higher returns and tax benefits that PPF investments offer over the long term.
Risk tolerance
Underestimating risk tolerance
One big cognitive bias is that we underestimate our risk tolerance i.e. we want FDs, nothing else.
We think we can't take risks associated with other investments.
However, both PPF and FDs are low-risk options. The only difference is that one gives you better returns and is EEE.
Knowing your true risk tolerance might open the door to better returns without much extra risk.
Anchoring
Anchoring on interest rates alone
Investors tend to focus on current interest rates, without considering the full advantages of each option.
While FD rates may appear higher, PPF's tax-free interest and compounding can lead to significantly higher long-term returns.
By concentrating solely on rates, investors overlook crucial aspects like tax savings and compounding benefits, which ultimately influence the success of their investments.