(This article was first published in Live Mint.)
Young India is not saving as much as it should. In fact, the average Indian is probably paying more taxes than she needs to. Even the ones who are making tax-saving investments are not investing well enough to achieve long-term goals.
An analysis of Indians’ investment patterns has revealed that earners in the age group of 20-29 years are not making the right investment decisions. The Employees’ Provident Fund (EPF) and the Public Provident Fund (PPF) account for around 50% of the tax-saving investments done by Indians. The life insurance premium and home loan interest we pay are next in the list of most-used tax-saving investments. It is after all of this that the equity-linked savings schemes (ELSS) come. Only an approximate 2% of Indian taxpayers invest in tax-saving mutual funds.
Everyone should have a significant portion of their tax-saving portfolio in ELSS funds because they can help you plan for and meet long-term financial goals. 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
Here early means in the first or second month of the financial year itself. 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 the portfolio can be rejigged to meet your goals. This type of flexibility is possible only if you begin early in the year.
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 1.5 lakh annually under section 80C of the Income tax Act, 1961. This includes your life insurance premium, school tuition fees for two children, home loan repayment, among others. You can invest further if you have room left to avail the section 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.
•Public Provident Fund (PPF): It 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.
•National Pension System (NPS): It 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.
•Tax-saving fixed deposits: These are probably the easiest tax-saving investments you can make. They come with a lock-in of 5 years and offer guaranteed returns as well as capital protection.
Apart from these, there are others such as the Senior Citizens’ Savings Scheme, National Savings Certificate and unit-linked insurance plans. Which of these investments should you put your money in? The answer is diversification.
Step 3: Diversify
An ideal portfolio should have allocation to equity as well as debt. 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, NPS can be avoided as it is not tax-efficient upon maturity.
Step 4: Keep track
Your fixed income investments such as 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. A quarterly check would suffice. 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 the course
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 staying on course is important.
ELSS funds have become even more important after what we have seen in the last couple of months, particularly after the Budget. These 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.