Manu Nedunkandathil, CFP
Don't Just Save Tax, Create Wealth Too
Updated: Aug 20, 2021
This is a story that I heard some time back. One day two friends, an American and a Japanese were feeling adventurous and they decided to go camping in the forest, which was known for its ferocious tigers. After a whole day of trekking, they finally found a spot in a clearing to camp for the night. They set up their tent there and after a good supper went to sleep. Just as they were drifting into a deep sleep, both of them heard a tiger roaring nearby their campsite. They could sense that the tiger was approaching their tent.
Realising that they are in danger, both of them jumped out of their beds. The American started to run. And as he was about to start he decided to look back, and to his surprise, he sees the Japanese wearing his shoes. This made the American laugh and in a sarcastic tone he says, " Just because you have your shoes on, you are not going to run faster than the tiger".
To this, the Japanese replied, "I don't need to run faster than the tiger to save my life. As long as I can run faster than you, I am safe".
For an investor, the American (no offenses) and the Tiger are like taxes and inflation. One eating away the returns and the other value of money. Your investments will turn to wealth only if it is growing at a pace faster than the taxes and inflation. Otherwise, you will never win the race and always end up being eaten by the tiger. The choice is simple. Nobody wants to be eaten by a tiger.
For a growing economy like India, inflation is a reality no one can escape from. But taxes can be managed to reduce their adverse impact on the investments.
Though tax avoidance is a crime, there is no harm in being tax efficient. It is just being smart. Section 80C to 80U falling under chapter VI-A of the Income Tax Act provides for permissible deductions from the gross total income of an assessee.
Since discussions in detail about all the sections is outside the purview of this blog, I will restrict myself to section 80C which is related to investments.
Today an investor is bombarded with various investment products which offer tax relief under section 80C of the income tax act. It is like a child being offered a plate filled with different pastries to choose from. Each one of them looking equally appealing and delicious, making it harder to choose.
However, is it so simple as it looks? Let us look at some of the popular products available in the market and also the pros and cons of each.
So, which one is the right investment product for tax saving?
The best or the right investment product is very subjective. The investment product must suit individual risk profiles and investment goals. However, having said that, if you look at the lock-in periods of each investment product mentioned above, you can see that each tax-saving product comes with a lock-in period varying between retirement age to 3 years. NPS being the product with the highest lock-in period, followed by PPF and so on.
They say "You can't have your cake and eat it too." But what if you can??
If you are investing in any of the products above for the purpose of tax saving, invariably, liquidity goes out of the window. So, if you are ready to block your money for the next 15 years or above, why not choose a product which not only saves tax but also has the least lock-in period and having the ability to give higher returns beating the tiger (taxation and inflation) in the long run.
Of all the products mentioned in the list, ELSS is the only product with the least lock-in period of 3 years and is transparent with its performance and expense details. Though risky in the short term, in the long term ELSS mutual fund schemes have the ability to beat taxation and inflation and give positive returns.
With the help of the table below, I have tried to capture the performance of a few ELSS schemes for your benefit. To measure the performance, investment is assumed to be made on any day between 21st November 2002 to 20th November 2003 and the value of the same is taken exactly 15 years later in the year 2017-18.
From the analysis above, it can be observed that even the worst-performing ELSS fund has on an average given a return of 16.52 % CAGR, with the lowest return being 12.77% CAGR and the highest being 18.35% CAGR in the period of study, which by any standards is way better than any of the conventional tax saving investment products.
To put things in perspective, the average inflation during this period was 7% pa and in the same period, the safest product PPF has grown at an average rate of 8.5% pa. This implies, in absolute terms, Rs. 1 lac invested in 2002-03 would have become Rs. 3,40,000/- in PPF. Comparing that with investment in the worst-performing ELSS scheme, even if you had invested on your worst day it would have become Rs. 6.06 lacs in 15 years. And if lady luck was shining on you and you had invested in any of the top two schemes on the best day of the year, your investment of Rs. 1 lac would have grown to more than Rs. 20 lacs in 15 years.
The moral of the story
As the chief steward of resources of the family, saving tax is important so that your family gets the rightful share of your hard-earned money. But, if in the process, if you can create wealth too, then, why not?
Today when the world is talking about increasing work efficiency, isn't it logical only to ensure that your money is also working as efficiently for you as you are?