Tax-efficient investment planning for FY2016-17 in 5 steps

Investment planning FY2016-17

First up–the hard facts: Young India is not saving as much as it should. In fact, the average Indian in the 20s is probably paying more taxes than he or should needs to pay. Even if you are making tax-saving investments, you are not investing well enough to help you achieve your long-term goals. And the same is the case with people in their 30s and 40s as well.

An analysis of the investment patterns of Indians has revealed that earners in the age group of 20-29 years are not taking the right investment decisions. The Employee Provident Fund (EPF) and the Public Provident Fund (PPF) account for around 50% of the tax-saving investments done by Indians, partially because of the mandatory EPF deduction and PPF’s popularity. The life insurance premium and the home loan interest we pay are next in the list of most-used tax-saving investments–around 20% between them.

It is after all of this that the Equity Linked Savings Scheme (ELSS) come. Only an approximate 2% of the Indian taxpayers invest in tax-saving mutual funds. This is a major missed opportunity. ELSS funds invest in the stock markets and while they can be risky in the short-term, they are best placed to generate inflation-beating returns over the long-term. Everyone should have a significant portion of their tax-saving portfolio in ELSS funds because they can help you plan for and fulfill long-term financial goals.

That said, not all is lost. The silver lining here is that it is never too late to start. It doesn’t matter what age bracket you fall under, we have prepared a 5-step guide for you to plan your tax-saving investments for FY2016-17.

Step 1: Start early

When you plan your investments, you make sure you take informed and calculated decisions. You have the time on hand to assess and review your investments through the year and make changes if required. Repeatedly underperforming investments can be replaced and your investment portfolio can be rejigged to meet your goals. This is the type of flexibility that is possible only if you begin early in the year with a proper plan in place.

Step 2: Choose suitable investments

This brings us to understanding the tax-saving options you have. Any individual taxpayer or HUF can save up to Rs 1.5 lakh annually under Section 80C of the Income Tax Act. This Rs 1.5 lakh includes your life insurance premium, school tuition fees for two children, home loan repayment, etc. Beyond these expenses and payments, you can invest further if you have room left to avail the 80C benefit.

The investment options are many, but the most popular ones are the following:

  • ELSS funds: These are equity-linked mutual funds that come with the lowest lock-in of only 3 years. These tax-saving mutual funds don’t offer guaranteed returns or capital protection but since they invest in the stock markets, they are best placed to beat inflation and earn high returns over the long-term. Plus, your investments become tax-free when you hold them for over a year.
  • PPF: The Public Provident Fund is probably the most-used tax-saving investment. It offers guaranteed returns, capital protection and tax-free withdrawal upon maturity, but the returns may not be too meaningful over a long period. Another drawback of the PPF is that it has a long lock-in of 15 years.
  • NPS: The National Pension System is an equity-linked investment to a certain degree. The maximum exposure to equity can be 50%, which is at the discretion of the investor. However, you can only withdraw from the NPS upon retirement and that will be taxable. Another disadvantage of the NPS is that you have to use 40% of your corpus to buy annuity upon retirement, and the annuity rates in India are not too great.
  • FD: Tax-saving fixed deposits are probably the easiest tax-saving investment you can make. They come with a lock-in of 5 years and offer guaranteed returns as well as capital protection.

Apart from these investments, there are others as well like the Senior Citizens Savings Scheme, National Savings Certificate, ULIPs, etc. So, the question that comes up next is which of these investments should you put your money in? The answer is diversification.

Step 3: Diversify

To diversify is to build a portfolio of different kinds of investments. An ideal portfolio should have allocation to equity as well as debt. The younger you are, the higher you can invest in equity. And vice versa. The amount of risk you can assume would depend on your age and risk profile. In most cases, young people should have at least 50-70% of their tax-saving investment portfolio allocated to ELSS funds. If you are comfortable with a higher exposure, that’s even better because the longer you stay invested in ELSS funds, the more you will earn through the power of compounding interest.

The remaining part of your portfolio should be in PPF and FDs. At the moment, the NPS is an investment that most people can avoid because it is not tax-efficient upon maturity. At least 40% of the NPS corpus has to be used to purchase annuity and the rest is added to the subscriber’s taxable income.

Step 4: Keep track

Your fixed income investments like PPF and FDs don’t need to be watched. But you should have a periodic look at your ELSS funds since their performance fluctuates with the stock markets. But this doesn’t mean you check their performance every day. A quarterly check would suffice. The good thing about ELSS funds is that you can stop investing in a fund at any time, even if you’re in the lock-in period. Hence, a fund that does poorly on a continuous basis can be replaced by another fund to make sure your portfolio returns don’t suffer.

Step 5: Stay on course

This is probably the most important of the 5 steps. Getting started early and building a portfolio is one part of investment planning. What is just as important is not giving up somewhere in the middle. And this applies to not only tax-saving investments, but other investments as well. The finest benefits of an investment are reaped when you invest regularly and stay invested. It is easy to get influenced by emotions or economic conditions, all of which will make you want to either stop investing or pull out whatever money you can. But, the right thing to do at that time would be to take a walk till that feeling passes away. Staying on course is as important as getting started.

To conclude, ELSS funds have become even more important after what we have seen in the last couple of months, particularly after the Budget. Even though the EPF tax proposal put forward in the Budget was withdrawn, it gave a fair indication of what to expect in the future. Coupled with that, the lowering of interest rates on fixed income investment avenues like PPF, SCSS, etc makes it prudent to have a good part of your tax-saving portfolio in ELSS funds.

ELSS funds, after all, are the only instrument that can give you the best of both worlds–tax saving as well as long-term wealth creation. So, get started, keep investing and stay invested. That is literally all you need to do.

This article was first published on Live Mint on 9 May 2016.

Image courtesy of moomsabuy at FreeDigitalPhotos.net.

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