INCOME TAX

Take time to invest

Investments should be planned meticulously, and well ahead of time

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Nitin Balwani once overheard one of his friends talking on the phone about selling his investments. Once the conversation was over, Balwani, dean, planning and development, IFIM Business School, Bengaluru, realised that the financial product his friend had invested in had not made enough money—at least not as much he was promised it would—and that he would lose money if he cashed out. “He was visibly troubled so I asked him what the product was,” Balwani told THE WEEK. “He had no idea. [When I asked him if] he had the [relevant] documents, he replied in the negative. He had invested in it based on a friend's recommendation. That is the story of most investments. People will invest based on a friend’s advice or the bank’s advice, especially to plan for tax exemptions. People invest just to save taxes, without realising that they could have been better off by not falling for tax-saving traps and investing professionally.”

“More and more consumers are researching before they purchase and persistence has improved by leaps for the industry.” - Manik Nangia, director, marketing and chief digital officer, Max Life Insurance
“As per provisions in the IT Act, there are 26 allowances and 25 perquisites through which salaried employees are permitted by law to save taxes.” - Ramki Gaddipati, chief technology officer at Zeta, a fintech company
“People usually never pay for professional advice and try to do it on their friend’s advice or based on their own understanding of choices.” - Nitin Balwani, dean, planning and development, IFIM Business School, Bengaluru
“Investing wisely is a tough call to specify, but one can think of prudent investments in a given set of circumstances, be it social, financial or personal needs.” - Subramanyam S., CEO, Ascent HR

Balwani said people are usually shown the green shoots of what a product did last year and promised a long-term result on that basis. “Only, the product cannot sustain for the next year, forget five years,” he said. “This puts all the planning in a tizzy. The National Pension Scheme (NPS) is a case in point. It would work if you are 25 and have a 35- to 40-year horizon. However, if you are 50, the pension that you would get after 20 years would be too meagre to make any difference. In that case, you would be much better off paying tax on that amount and investing in better performing asset classes.”

As we approach the end of the financial year, we see a large number of salaried individuals making that last-minute investment to save income tax. This leaves them little time to do proper research and there is a high probability of choosing wrong products. As saving tax becomes their sole objective, they often tend to ignore important parameters like returns, tax exemptions on maturity, lock-in periods, asset class and risk appetite.

Experts say that people usually make poor investment choices at the end of the financial year because there is no proper portfolio analysis and structuring. “People usually never pay for professional advice and try to do it on their friend’s advice or based on their own understanding of choices. This is fine if the friend is a professional or they have adequate knowledge, but that is not the case most of the time,” said Balwani.

Manik Nangia Manik Nangia

Said Naveen Kukreja, CEO and cofounder, PaisaBazaar.com: “Anybody lacking in knowledge of tax-saving instruments is susceptible to making mistakes. Many seasoned investors, too, try to time their Equity Linked Savings Schemes (ELSS) investments in the hope of buying units during market dips or corrections. However, this strategy backfires if the market continues with its upward trend till the end of the financial year.”

Mistakes are bound to happen, but many people often repeat them. “When it comes to direct investment into equity, herd mentality as well as fear of missing out on the next big investment opportunity continues to be at the centre of common investor mistakes,” said Vishwanathan Iyer, professor, finance and strategy area, associate dean (academics), T.A. Pai Management Institute, Manipal. “In the case of mutual funds, these investments are generally made at the last possible minute and with very limited planning about mapping these investments to their overall goals. Furthermore, the subsequent decisions, such as whether to switch from one scheme to another, change asset allocation or exposure to certain asset class, etc, are never given attention. People generally go for the default option and seldom make any informed changes.”

Market analysts also say that often, mistakes happen simply because the investor depended on someone else’s research to take an investment decision. “Personal finance is a very specific and personal matter,” said Navin Chandani, chief business development officer, BankBazaar.com. “What is good and relevant for one person might not be the right option for another. This is something that people forget while soliciting advice from friends and family. The wrong financial advice, no matter how well-meaning, can be disastrous. Financial investment has to be goal-based to provide the best returns when needed. They should also be relevant to your financial situation. Different people have different goals and financial situations. You need to match these with your financial plans. For instance, if you are planning to take a break from work to pursue higher studies, you would need to save up differently compared with your friend who is saving up to buy a new car. If you are planning to utilise your funds in the next two to three years, you need to invest in mid-term instruments compared with liquid funds if you are holding on only for the next six months. The key here is to do your own research. Do not fall for traps that promise extremely high returns. The higher the returns, the higher the risk. If the returns sound impossibly high, they are, in all probability, extremely risky.”

Ramki Gaddipati Ramki Gaddipati

There is no doubt that investing is all about meticulous planning, which involves considering your risk-return preferences, investment time horizon, liquidity requirements and tax considerations. “It is important that investing decisions are planned in advance and executed meticulously. Investing should not be an afterthought,” said Kaustubh Belapurkar, director, manager research, Morningstar Investment Adviser. “Investment should be made all-year round rather than only towards the end of the year. Systematic investment plans are a brilliant route to reduce market timing risk. Also, it is important not to pick products purely on past returns. Often, investors are swayed by reports on the short-term performance of funds. Choosing funds purely on the basis of this metric can be detrimental to your investment portfolio. While performance gives a guide into how a fund has done in the past, it is by no means a holistic metric to base your decision on. For starters, try to understand if the fund meets your risk return objectives as an investor. For instance, mid- and small-cap funds may have been the best performers in 2017, but the question you need to ask yourself is whether you can handle the interim volatility that comes with these funds.”

Similarly, experts such as Subramanyam S., the CEO of Ascent HR, say that when someone buys a repetitive investment, for example an insurance policy or an SIP, the plan tends to become more structured for the fear of losing benefits rather than making it a structured investment. “At the same time, the idea appears very centric to tax planning only and the best example of this attitude is in selling insurance as an investment and a money back scheme. While a wealth manager might explain investments or insurance to an intending investor, last-minute requests for tax planning are handled by entry-level advisers and, hence, structured planning is a casualty as opposed to the immediate and more visible goal of savings in tax and the consequent cash on hand,” said Subramanyam.

Investment experts have found that for individual tax payers (and specifically the salaried class), reducing the taxable income and ultimately the outflow due to taxes continue to be the predominant motivators. “The additional investment into NPS is restricted exactly to the extent of providing tax benefit,” said Iyer. “While there is nothing wrong about taking advantage of these provisions, the worrying factor is that these investment decisions are never made for the right reasons.”

Nitin Balwani Nitin Balwani

A few industry experts said that there was a need for salaried employees to understand their salary structure so that they do not lose out on tax-friendly measures. “As per provisions in the Income Tax Act, there are 26 allowances and 25 perquisites through which salaried employees are permitted by law to save taxes,” Ramki Gaddipati, chief technology officer at Zeta, a fintech company, told THE WEEK. “Some of them are fuel and travel reimbursement, books and periodicals, communication reimbursements, gadget allowance and much more. With the government’s decision to introduce the standard deduction of Rs 40,000, employees’ salary structures will require an overhaul. Also, removal of medical and conveyance reimbursements now necessitates the need to opt for other tax benefits that will help them save tax.”

Insurance experts such as Manik Nangia, director, marketing and chief digital officer, Max Life Insurance, say that though in the past few years they have seen that last-minute investments in the last quarter have come down, the period constitutes more than a third of sales for the insurance industry. “More and more consumers are researching before they purchase and persistence has improved by leaps for the industry,” said Nangia. “So, we believe that purchase decisions are a lot more conscious now. It is important to think long term. Savings plans have to be realistic and it is important that approximately 1/5th of the income for anyone earning upwards of Rs 5 lakh per annum should be directed towards long-term savings instruments. Risk profile is an important consideration before making the choice of instrument. Mutual funds are good medium-term instruments, but equity funds aren’t good for those who fear potential capital erosion. Similarly, long-term retirement plans ought to have an equity component so that portfolio kickers come from earnings on equities. Unit-linked insurance plans and pension plans offer many such options.”

Whether it is that last-minute investment or a carefully planned one, a person needs to invest wisely to avoid mistakes. There are a lot of options available, but one needs to be systematic. “The first advice is to do a proper asset allocation,” said Balwani. “If the asset allocation is rightly managed, everything falls in place. If that is wrong, nothing works. Diversification is the key. People at the beginning of the career should invest all their money in the stock markets; first in ELSS for taking section 80C of the IT Act benefit and the remaining in SIPs. This is proven to generate the most wealth over a long period of time. For ELSS and mutual funds, direct investment is most beneficial as that works out to an advantage of 1 per cent every year, which is quite significant over a long period. For savings when the income is limited, the best way is to earmark a saving as soon as the income hits the bank and then forget about it. Even if it is a small amount, letting it grow over a period of time will work wonders. For example, just Rs 1,000 saved every month and put in SIP grows to a cumulative Rs 17.5 lakh with a 16 per cent return, whereas the investment over 20 years is only Rs 2.4 lakh. That is the power of compounding. The key to good investment is proper asset allocation and long-term thinking.”

Subramanyam S. Subramanyam S.

Another expert said the first step towards holistic tax planning was aligning one’s tax-saving investments with financial goals at various life stages. “Start by calculating the quantum of tax-saving investments you need to make after considering various mandatory payments that qualify for tax deductions, such as home loan principal and interest payments, interest component of education loan EMIs, EPF contribution and premiums for life and medical insurance premiums,” said Kukreja of PaisaBazaar.com. “Invest this amount through SIPs in direct plans of ELSS schemes as it beats other investment instruments under section 80C in terms of returns, lock-in period, liquidity and transparency. SIPs will allow you to invest in a disciplined manner every month without the need to compromise on lifestyle.”

Experts also say that, for a salaried individual, investment in real estate should ideally be restricted to self-occupied property to save tax, but many salaried class investors fall into the trap of investing in real estate with an intention to make large capital gains. What most people do not realise is that investment in real estate is lumpy, extremely risky and has much lower (rental) yield compared with other asset classes. Same goes for investment in gold. Investment in physical gold does not generate any yield.

Some advisers say that for tax choices, investors mostly use 80C. “People who are better off invest in real estate first as that is the advice they get from their elders, locking in their capital in one asset. With the current prices, they do not have enough to invest anywhere else, getting stuck on the classic one-asset pony. As this is leveraged, if the asset performs, the returns are excellent, otherwise they are losing money. Worse, they cannot even sell the asset as it becomes a prestige issue,” said Balwani.

Experts like Subramanyam say that through investments, priorities for every individual should be to cover risk by way of adequate insurance, be it for health or life, create small savings for contingencies, plan for pension unless the employer is facilitating it in any way, and look at leveraging his finances for asset creation or luxury needs, given the numerous options of finance available. “Investing wisely is a tough call to specify, but one can certainly think of prudent investments as listed above in a given set of circumstances, be it social, financial or personal needs,” said Subramanyam.