The sin of rushing into saving tax without having goals
January, 31st 2013
In putting our tax special together, we encountered, yet again, a persistent investor psyche that looks at financial products through the narrow prism of tax saving. And tax saving through insurance plans. This psyche cuts across backgrounds and insurance products are seen as something that seemingly kill three birds with one stone—they provide risk cover, investment return and tax benefits.
We spoke to people from different age groups. Unfortunately, but not entirely unexpectedly, people who may have needed insurance the least had it the most. A retired person and a 26-year-old single girl relied solely on insurance policies to save taxes. And no these policies are not pure insurance cover, they are investment products with a thin layer of life insurance.
According to data from the Reserve Bank of India, after bank deposits, insurance was the next big vehicle for household investments in FY12. In fact, the same has been true for some time now. Serviced by an army of around 2.36 million agents and with the triple attraction of insurance, investment and tax benefits, it is hard to look away from an insurance policy, especially when the HR deadline is looming ahead. This is perhaps one of the reasons why insurance policies get bought the most in the last quarter and get dropped soon after.
But what does this say about us as investors. It tells us that tax planning still remains a goal in itself and so big that it most often comes at the cost of financial goals. In the last minute rush to save taxes, we pick up mindless investments and leave a trail of regret over the years. To sort this problem out, begin with understanding the cost of saving taxes. For someone in the highest tax bracket of 30%, Rs.1 lakh investment in section 80C instruments would save around Rs.30,000 in taxes. Make that investment unwisely and Rs.1 lakh is the cost for saving just Rs.30,000.
Looking at tax saving alone is like walking on the tightrope with very dodgy balance. You are bound to slip. Tax saving works best when it is incidental to the larger goal of financial planning. It’s like another spoke in the wheel of a financial plan that rolls smoothly towards your goals. And if you have clear goals in mind you will realize that most goals lend themselves to tax saving. For instance, retirement: Long-term vehicles such as Employees’ Provident Fund, Public Provident Fund (PPF) and even equity-linked savings schemes not only help you build a neat corpus for your sunset years, they also give you income-tax benefits both at the time of investment and at maturity.
But mindless investment is not the only mistake most investors commit. Leaving everything to the end of the year is a bigger sin and perhaps the root cause of rushed and often wrong investment decisions. Bunching up your investments not only puts pressure on your cash flows, and some of us resort to high-interest debt to make investments, it is also an inefficient way of managing your money. Stagger your investments or make them early. For instance, by moving your investments in the beginning of a financial year in PPF, you gain around Rs.2.86 lakh more on an investment of Rs.1 lakh at the current PPF rate of 8.8% per annum. This is because your money is given more time to compound.
Staggering your investments on the other hand takes the pressure off your cash flow and instils financial discipline. And in doing all this, make use of technology. In the last few years, technology has transformed our access to financial products. You don’t have to scout for an agent-turned-financial adviser to help you with investments. Most financial products are now available at the click of a button. So not only can you invest in mutual funds online but also in government-run PPF. And if you don’t have a lump sum, just issue an ECS (electronic clearing system) mandate and start a systematic investment plan (SIP) in PPF as well.
Lastly, you now have professional financial planners who are equipped to dish out advice across the length and breadth of financial products. With the growing army of financial planners to help you make intelligent investment decisions and products at the click of a button, it is foolish to wait till the end of the year to make investments. Follow this pattern instead: fix your goals, assess your risk appetite, make an asset allocation and then scout for products. And do this at your own pace and not under deadlines.