The tax season is just round the corner! And there are too many tax saving options available broadly categorized under two heads: one equity and two debt products! There is your financial consultant but more often than not he might suggest only those products that will get him the highest commission! Obviously you are confused! How about analyzing the right tax saving product for you? Want to know how? Read on.
To begin with ask yourself these two questions: your risk tolerance level and what stage in life you are in. But why should you do it in the first place?
Importance of finding your risk profile
Finding answer to this question can lead you to the right tax saving plan! Analyzing your risk tolerance level will help you shape up your investment portfolio and get the best out of it. Now what is risk tolerance? Your investments are prone to both positive and negative changes. In the risk of negative changes the big thing is to find out how much you can afford to lose on your investment. This is your risk tolerance level.
Financial risk tolerance level
How to find your risk tolerance level?
There are two sides to it: one is financial and the other is emotional. The financial risk tolerance level is self explanatory. That is the amount of money you can afford to lose. If you can afford to lose more money then you have a high risk tolerance level and if you cannot afford to lose huge money your financial risk tolerance is moderate and if you do not want to take risk at all your financial risk tolerance is called low.
Emotional risk tolerance is all about the stress level that you are put into when you lose money on your investment. The more your stress is, the lesser is your risk tolerance.
Investment options for conservative, balanced and aggressive investors
Investors fall into three categories based on their risk profile: conservative, balanced and aggressive.
As the name implies conservative investors are averse to taking risk. Typically they have a low risk tolerance and prefer investing in safe havens like Public Provident Fund (PPF), National Savings Certificate (NSC), and Employees Provident Fund (EPF), Endowment plans when it comes to life insurance and on tax-saving bank fixed deposits.
Investments in low-risk products
The balanced investors are those who wouldn't mind taking some amount of risk but still would park their investments in low-risk products like balanced unit linked insurance plan or ULIPs. In other words, their risk tolerance is moderate.
Those investors with the highest risk tolerance levels belong to the aggressive category. They have an appetite for taking risk. If you belong to this category you could invest in tax saving products like the equity linked savings scheme or ELSS.
Pros and cons of each
Let us see the pros and cons of each of the tax saving products in all three categories of investors.
Products for conservative investors
With low or almost nil risk tolerance level the conservative investors usually go for fixed income products that would secure their investment.
Products for the balanced investors
The risk tolerance level of these investors is moderate and they invest in low-risk products as the conservative investors and also in unit linked insurance plan or ULIPs.
Deciding investment portfolio composition
Products for the aggressive investors
These investors with high risk appetite can invest in tax saving products as the conservative and the balanced investors do. Apart from this they can also invest in equity-linked products, which generally do better than the conservative products but returns may vary with funds.
Importance of having goals
Your stage in life will also have a say in deciding your investment portfolio composition. If you are someone young then you could consider investing in equity like ELSS, ULIP or take a home loan or educational loan to save tax. Once you grow older you can slowly get out of these avenues and invest in fixed income tax saving products like the PPF, FDs etc.
How to use risk profile + goals to choose the right option?
Returns on your investment are important but this alone should not be the driving factor in deciding your investment choice. There is no investment per se that can save you tax and simultaneously secure your investment and give highest return. Your final choice of tax saving investment should be guided by both your risk profile and your goals in life which again depends on the stage of life you are in. Remember, the goal is to have an investment portfolio that can give you decent returns and the risk tolerance level you can handle.