A few days back, in a comment made on the proposed mandatory corporate social responsibilities (CSR), Biocon founder Kiran Mazumdar-Shaw pointed out that when you make something compulsory, all you get is cosmetic actions rather than something that will actually have an impact. She also gave an interesting example drawn from her own experiences. “For many years now, the government has been giving substantial tax-breaks for R&D (research and development) activities, yet real R&D in the corporate sector started only when the right combination of market conditions and a new breed of entrepreneurs came about. The tax breaks didn’t actually produce the kind of behaviour that they were trying to incentivise. Instead, they just produced elaborate attempts to game the system by going through the motions of R&D, which is what mandatory CSR will also do.”
However, that’s not what I'm writing about today. What I'm writing about is that there’s an exact counterpart of this phenomena in tax-saving investments. Some of the worst investment decisions that individuals take is with their tax-saving investments. Deposits with long lock-ins that give a return hardly more than the inflation rate; insurance schemes that eat away most gains in agent commissions; tax-saving mutual funds chosen with scant regard to performance track-records — all these (and more) seem to be the norm when it comes to tax-saving investments.
Why does this happen? The basic reason is that there is a confusion of goals between saving tax and making investments. The typical investor makes this decision either in late March under the duress of having the deadline slip by, or under intense selling by a salesman who’s experienced at fudging between tax benefits— which are not unique to his product— and the inherent characteristics of the products. At the end of the day, people make bad investment decisions and if they ever realise it, they console themselves by saying that that at least they got tax benefits.
This duality of concerns—tax as well as investments—prevents clear-headed thinking about just exactly what one is getting out of an investment and whether the quantum of any disadvantages are actually worth the quantum of tax benefits. Investors should work on eliminating both these sources of bad decision-making — time pressure as well as not thinking about these investments as investments.
Eliminating the time pressure is simple. Just plan these investments as early in the year as possible. If you haven’t done so, then this is the right time to do so. However, the other part needs a careful approach. An investment should be made in a particular product only if there is a need for it. For example, if you do not need a fixed deposit, but would rather invest in equity, then invest in an equity-linked tax-saving product or vice versa.
Any investment has to first make sense as an investment, and only incidentally be a tax-saver.This article was originally published on August 16, 2010.
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