Where do you not get compounding? Even a lowly savings bank account money gets compounded if you let earned interest remain there. Compounding is simply getting interest on interest – no big deal as it would happen in any sensible saving or investment avenue.
But what matters is the investment perspective. If you have an investment horizon of, say 20 years and, in the name of safety, you put it all in PF, you will lose big time. Most of the times, safety is the biggest risk. Why do I say that?
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Let us say the long term rate of inflation in India is 6%, you are in 30% tax bracket and you invest only in avenues like bank FDs, Senior Citizen Savings Scheme (SCSS), Post Office Monthly Income Scheme PO MIS), real estate in general etc and your portfolio has only these, then unless your portfolio earns 8.6% returns CAGR (Compounded Average Growth Rate, or in simpler term, returns year-after-year), you're earning negatively, which further means that your hard-earned money's value is going down continuously.
Where does 8.6% come from?
Deduct 30% tax + cess (=31.2%) from 8.6%. That is 5.92%
Deduct 6% inflation from it (since your money should grow at least that much to just meet the rising costs): 5.92% - 6% = NEGATIVE 0.08%
So if you earn less than 8.6% overall in all your investments and savings combined, you're losing big time.
PF contribution less than 5L a year has no taxation. So 7.1% less 6% inflation = 1.1%, ie, you still earn positive.
Is there anything which returns positive in real terms over the long term? Only Equity and nothing else. Tax of only 10%, long term returns of average 12-15% CAGR.
Does it have risk? In the long term beyond 7 years or so, as per empirical data, you have short term volatilities but hardly any risk.
Let me give an example to those who put, say, 80K in PF per month today. At 7.1% returns with approx 42K tax-free and 38K taxable, you will accumulate approx 3.66 Crores in 20 years.
If you put this 38K in equity, your corpus is likely to be 46% higher at 5.35 Crores taking long term taxation of equity to be 10% and growth rate to be a conservative 12% CAGR. I'm not even putting the Rs 1 Lakh a tax-free exemption on equity on redemption here.
