Why tax planning alone won't make you rich?

While it is important that you invest in tax-saving schemes; but do not look at these as mere tax-saving schemes.

Why tax planning alone won't make you rich

Warren Buffett once compared making something out of one’s life to shaping snowballs. “Life is like a snowball,” he said. “The important thing is finding wet snow and a really long hill. “Elsewhere, he’s said to have quipped: “You can’t produce a baby in one month by getting nine women pregnant.”

What the billionaire was referring to in the first instance was the need to seize opportunities (wet snow) and take a long-term approach to investment with these opportunities (rolling the snowball down a long, snow-covered hill, so that it collects more snow and grows in size). 

In the second instance, he was calling for patience while investing.

Related: How advance tax can help you stay on track with tax payments 

Lessons for us

When you come to think of it, whatever we do with our money – letting it lie dormant, grow steadily but slowly in tax-saving instruments such as PPF, or ride a rollercoaster in the capital market – is basically playing in the snow. The size of our investment returns at the end of a given period is like the snowball at the bottom of the hill: the longer the incline the more the snow – and the bigger the snowball. 

Around the world, investors are looking at India as a long-term investment destination. You too can benefit from the country’s growth if you can ignore short-term volatility and invest for the long-term.

Remember, while it is important that you park some of your money in tax-saving schemes; do not look at these beyond what they are: mere tax-saving schemes. Nobody got rich from looking at health plans and PPFs and bank deposits (recurring or FDs) as money-making investments; these are security blankets for you and your family against any adverse situation that may arise. If you do want to get rich, you should look at investing in the capital market.

For instance, mutual funds typically give about 15% returns annually in the long run. In other words, if you invest in mutual funds for 4-5 years, the investment would  is likely to double at the end of that period. Compared to this, bank fixed deposits, company fixed deposits or recurring deposits will yield you returns of around 7-8%, meaning it will take 8-10 years for your money to double.

The upshot is that the ideal way to go about using your money to make more money is to have a diversified portfolio based on your risk appetite and financial goals. Get yourself a financial advisor, let him or her advise you on the right financial instrument(s) for you, and look at investing regularly and persistently for the long term (more than 10 years). 

There's no point being impatient; as Buffett said, you can’t have one baby instantly from nine women who got themselves pregnant at the same time to cut down on the nine-month birth cycle.

Related: Tax Planning for every age group 

Investing the right way

You may wonder why a financial investor is required. Though it is not mandatory, it is advisable to have one, because an investment that’s ideal for one person may not be suitable for another, based on their respective needs, priorities, and financial goals. There is no one-size-fits-all formula, and it is here that a financial advisor can guide an investor – that is, you – to make the right choice.

Given this, discuss and finalise the following with your advisor to chart out the best way to invest your money:

  • Your financial goals: You need to zero in on what you are investing for; a car would be a short-term goal, a house a medium-term goal, and your kid’s marriage or your retirement corpus a long-term goal (generally, a time period less than three years is considered short-term; 3-10 years as medium-term; and anything beyond 10 years to be long-term).
  • Your risk horizon: Decide on the extent you are willing to take risks: no risk, low risk, moderate risk or high risk. Low-risk investments usually pay the lowest yields, but are far less volatile than other types of investments; moderate-risk investments pay out over the long term; while high-risk investments can either return huge yields or entail huge losses. 
  • Investment period: You need to take a call on over what period you would like to invest – short-term or long-term (time spans explained above).
  • Investment amount: Also important is being absolutely sure about how much money you can practically afford to invest out of your entire savings; it’s wise to take guidance from a financial advisor.

Related: What makes tax-saving exercise an important financial planning tool 

How to go about it

Once you have reached clarity on these points, you can take the next step to building your investment portfolio, which should ideally be a mix of short-term investments and long-term investments, such as equities, mutual funds, debt products etc as well as traditional tax-saving plans and savings schemes. This way, you can have a balanced portfolio commensurate with your age as you grow older. 

Let us consider some options, including combinations that can be part of your investment portfolio. But first, let us look at a few secure options for capital protection:

  • Bank fixed deposits: A popular method of investing among individuals with low risk-appetite given their fixed, guaranteed returns, FDs offer an interest rate ranging from 6.6-7.35% for a period of one year, according to one analysis. The problem is that the interest is fully taxable so the post-tax return for someone in the 30% tax bracket is a paltry 4.55-5.25%. 
  • Public Provident Fund (PPF): A good long-term investment option, PPF yields 7.6% interest annually; deposits are eligible for tax deductions under Section 80C of the IT Act, and a maximum of Rs 1.5 lakh can be claimed in one financial year. PPF accounts have a maturity of 15 years, a period that can be extended in blocks of five years.
  • Post office: The Indian postal service has two savings schemes – recurring deposit (RD) account and monthly income scheme (MIS) – both offering 7.3% interest over a maturity period of five years; the schemes offer guaranteed returns as neither is linked to the stock or bond markets.
  • Sukanya Samriddhi: This is an ideal scheme if you have a daughter below the age of 10; the account can be opened in the child’s name at any public/private bank or post office, and will continue for 21 years; the maximum amount that can be deposited in a year is Rs 1.5 lakh and the minimum is Rs 1000. This investment is eligible for tax deductions, and fetches a healthy return of 8.1%.
  • Gold: A traditional and one of the most preferred investment options for Indians, the metal is still considered a good long-term bet despite being susceptible to market fluctuations.


Then there are the slightly ‘risky’ options, but to quote Warren Buffett again, risk stems from not knowing what one is doing. If guided by a capable financial advisor, the following options are good for growing your money quickly, though they are subject to market risks:

  • Equity-Linked Savings Scheme: Popularly known as ELSS, this equity fund investment enjoys tax deduction benefits under Section 80C of the IT Act up to a limit of Rs 1.5 lakh a year, and has a lock-in period of three years. Along with tax deduction, ELSS – which must hold at least 80% of the portfolio in equity securities – provides scope for long-term capital appreciation as it offers an opportunity to gain from market-linked returns from equity. 
  • Mutual funds: This is a product that pools money from a lot of people – who then become its shareholders – to invest in securities including company stocks/equity; mutual funds also buy bonds, short-term debt etc. If you decide to invest here, you are buying shares in that mutual fund, not in a company per se. People often invest in equity mutual funds through the Systematic Investment Plan (SIP) route, whereby a fixed amount is put in a fund in equal instalments over a fixed timeframe; SIP is a good way to go about it and returns are good (see above). 
  • Direct equity: This involves huge risk, so you need to be very cautious while putting your money in equity. Returns are based on market fluctuations.

Last words

Even as you go about building your investment portfolio, do not forget to take adequate risk cover in the form of health insurance and term insurance to protect your family; it is advisable to consider insurance a critical part of your financial portfolio and not just another investment option. 

Over and above everything, be patient, for money takes time to grow. And since we started with Warren Buffett, what better way to wind up than with some wise words from the frugal billionaire? Don't live on borrow, he says. “I’ve seen more people fail because of liquor and leverage – leverage being borrowed money. You really don’t need leverage in this world much. If you’re smart, you’re going to make a lot of money without borrowing.”


 

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