VR Logo

A Less Taxing Time

The tax-saving exercise must be part of a general investment plan

If you are thinking of your tax-saving investments now, you are way too late in the financial year to be doing so. Although it's true that the last day for making such investments is 31st March. The way most people invest, it is as if the law forbids tax-saving investments before about 2:30 p.m. on 31st March. Unfortunately, the best way to make these investments is to plan them in April and then execute them throughout the year. So, perhaps you should take the ideas in this article as guidelines, not for what to do for 2009-10, but for 2010-11.

Anyhow, I find that for tax-saving investments, we tend to think about tax first and investments later. As long as something saves tax, its characteristics as an investment are paid less attention to. Much of the time, waking up late to these investments means that they are chosen more for convenience than for suitability. For salaried individuals, it's typical that you are told by your accounts department somewhere around 25th January to furnish proof of investment immediately, or else extra money will be deducted from your February salary. At that point, your choice ends up being guided by convenience alone.

A better way to do this would be to make your tax-saving investments part of your normal investment plan which just happen to be admissible for tax rebate under the tax laws. The three most important parameters for an investment are the risk-return trade-off, the liquidity-locking period trade-off and cost. At one end are the government guaranteed schemes like the EPF, PPF and the NSC. These have relatively long lock-ins and returns of 8 to 8.5 per cent currently. However, I believe that given the mandatory lock-in of tax-saving investments, it makes sense for most investors to concentrate their investments into ELSS mutual funds. These funds have the lowest lock-in - three years - among all tax-saving possibilities. Given the term of the investments, the chances are that you would earn far better returns than in any other options.

There are two other options that give equity-linked returns-ULIPs and the New Pension System (NPS). Of these, ULIPs have a long lock-in- at least 10 years - coupled with high costs and poor transparency. Moreover, investors have to commit to continuous payments for a certain period - if they can't keep up then the effective cost shoots up to a ruinous level. However, since ULIPs are phenomenally profitable for insurance agents, you'll have to be particularly thick-skinned to stand up to the intense sales pitch.

In terms of sales intensity the very opposite of ULIPs is the NPS - no one seems willing to sell it. That's a tragedy because if you want your tax-saving investments to work towards your retirement kitty, then the NPS is likely the best option. However, the NPS should not be seen as investment avenue at all. It's a retirement solution and has practically no liquidity till retirement age.

Which brings us back to ELSS funds. These funds offer a combination of returns and a lock-in that is over relatively quickly. Considered purely as an investment, they are an excellent option. However, as I said up front, this is advice for 2010-11. As in any equity investment, one should stagger one's investments over a relatively long period of time. Ideally, you should estimate how much you'll need to invest and start a monthly SIP for that much amount in April.

However, if you haven't done that, it's still some time to go. Spreading your investments over equal amounts from now till the end of March is not a bad option. Either.