India has been on the road to transition in all the fields. Now the consumer is pampered with multiple choices everywhere be it fashion, automobiles, entertainment avenues or even for venting one’s ire (through social media). This is equally evident in products available in the area of pure financial products. Now the consumer is confused with the problem of plenty and sometimes gets trapped under mis selling by the distributor of the products. As a first principle of financial planning, all the investments should be mapped with your specific goals so as to ascertain its suitability or otherwise for a specific goal. One product can not meet the demands of all the investors as the risk appetite and time horizon of investment of each person as well as for each goal for the same person would be different. So one should know the risks involved in investing in each asset class.
- A :[Equity] and B :[Debt category of investment]
- A : Equity Investment
Higher Returns :Equity as an investment avenue is the most important of the all the pure financial products available. Historically equity investment , as judged from the base of Sensex of 100 for the year 1978-1979, has given around 16% annualised return over the last long period of 37 years. This is the only asset class which helps one to bear the inflation and get some positive return in the long run. And to add icing on the cake, surplus realised on sale of equity shares as well as equity oriented mutual schemes is either fully exempt or attracts concessional tax rates.
- Tax On Equity Investment
- ⇒For investment held for 12 months or less the tax rate applicable is 15% and
- ⇒In case the investment is held for more than 12 months the surplus realised is fully exempt provided certain conditions are satisfied.
Higher Risk : Though equity as an asset class gives better returns in the long run, it is equally risky as it is the most volatile asset class in the short term where one may even see his capital getting eroded. So the equity as an asset class for investment is suitable only for the people whose goal is long term and thus the investment horizon is long. In my opinion and based on historical data a person would not have incurred loss if one had invested in equity for a minimum period of 7 years. The probability of one losing money substantially goes down as the tenure for investment becomes longer. So equity form of investment is suitable for various goals like retirement, wealth building or even for child education and child marriage in case the investment is planned when the children are small and you have enough years to accumulate the required corpus.
How to invest in equity? So the next question that arises is how to invest in equity? One can invest in equity through two modes.
- 1.Directly investing in through brokers on the stock exchanges.
- 2.Equity exposure through indirect mode of investing in equity schemes of mutual funds.
Investment in equity directly :Let us start with investment in equity directly. In my opinion and experience investing is equity directly is a full time job and requires time and thorough knowledge of the economy, local as well as global because in the days of globalisation all the economies are interlinked and no economy is insulated from the vents happening outside the country. This also requires monitoring of the events happening which affect the industry as well as the Company one has invested in. For direct equity investment right time of both entry and exit are important which is generally not possible to do for an average investor.
Under the category of direct equity investments you can claim tax benefits under [Section 80CCG] in case you are first time investor to the extent of Rs. 25,000/- in case you make investments in equity shares of specified companies and satisfy other conditions. However there is no other tax benefit available under any other provisions of the income tax laws for investment made in direct equity shares. The dividend received on shares is presently fully exempt in the hand of the shareholder since dividend distribution tax is already paid by the Company paying the dividend. In previous Budget FM has also levied an additional tax @ 10% on dividends on the taxpayers whose dividends income exceeds 10 lacs in a year.
Equity through the indirect route of Mutual Funds :As against direct mode of equity investments, investors now have options to invest in equity through the indirect route of mutual funds. Since the fund managers are equipped with necessary knowledge and skills for investments and as investing is the full time job for the fund manager, the investment in equity through mutual funds is the right course of action for an average investor. Of late retail investors have started realising the folly of investing in equity directly. This is evident from the inflows into the equity schemes of the various mutual funds schemes. The mutual funds have seen an inflow of 92,000 Crores during the calendar year 2015 which is highest in the last ten years. So the proof of pudding is in the eating.
Investment in mutual funds can be made either through agents called mutual fund distributors or can even be made directly with mutual fund house under direct plans of the mutual funds. In case you are able to do your own selection, for which sufficient information is available online as well as in the print media. Almost all the mutual houses allow you to do transactions online, you should invest in direct plans of the mutual funds. The direct plans are beneficial for the investors as the fund houses are not allowed to debit distribution expenses like distributors commission and other distribution expenses to the direct plan which is debited to regular plans and thus generating higher returns for the direct plans as compared to regular plans.
Investments made in [Equity Linked Saving Schemes (ELSS)] of mutual funds are eligible for deduction under [Section 80C] within the overall limit of Rs. 1.50 lacs. Likewise investments made in qualified mutual funds schemes are also eligible for deduction of Rs. 25,000/- for the first time investors under Section 80CCG provided certain conditions are satisfied under Section 80CCG of the income tax Act.
- Investments in Equity whether directly or indirectly is suitable for the people
- ⇒Who have longer time horizon for investment
- ⇒Who have some ability to take risk
- ⇒Who are in active phase of their career.
- Debt as investment Asset Class
There are various instruments available for investing in debt. Investment in debt as an asset class comes with lower volatility accompanies with lower returns as well. There are various instruments available for investment in debts as well.
Bank Fixed deposits: traditionally have been the most popular form of investments for Indians in the past. There are pros and cons of this investment avenues as well. First the pros. The investment instruments has predefined and assured rate of return when you make the investment unlike investments in equity. The interest on fixed deposits is taxed at the slab rates applicable to you. There is a category of bank fixed deposits which entitles you for the tax benefits under [Section 80C] with the limit of Rs. 1.50 lacs. Such fixed deposits have to be made for a period of five years. Interest on all types of fixed deposits is taxable in your hands and tax is deducted in case the interest on fixed deposits exceeds the threshold limits. However you have the option to offer this for tax either on receipt basis of on accrual basis. In order to ensure even distribution of income it is advisable to offer the interest on accrual basis. This product is available for the people who want assured returns and do not have the ability to take any risk with their capital.
Debt Mutual Fund: Like for equity investments there are various products in the debt category available as well in the mutual funds stable. The products differ from liquid funds to debt funds catering to different category of investors based on the time horizon for investment and the ability to take risk. At the bottom of the bouquet is liquid fund with return almost mirroring the interest on bank fixed deposits. The liquid fund are least risky in the category with advantage of liquidity and being tax friendly. As the duration of the goal becomes longer one can invest in other varieties of the debt funds like ultra short term fund, bonds funds, Monthly income funds where a very small portion of money is invested in equity to give it a flavour of equity and some higher return.
In case of units of all the debt fund schemes no tax is deducted on the income and the income is treated as short term capital gains if the investment is held for 36 months or less and is taxed at the slab rate applicable to you. In case of the same are held for more than 36 months it becomes long term and the same are taxed @ 20% with the benefit of indexation. Please note that there is no tax benefit available for making investments in debt mutual funds under the income tax laws.
In addition to bank fixed deposits and units of various debt fund schemes one can invest in other investment products like [National Saving Certificate (NSC)] or [Public Provident Fund (PPF)] . Let us first discuss NSC.
National Saving Certificate (NSC) : In the year of purchase of NSC, you are entitled to claim tax benefits under Section 80C upto Rs. 1.50 lacs along with other eligible items. The NSCs have a tenure of 5 years and the interest on it is taxable however no tax is deducted on the same. This is an ideal product for the people who want to save the money for a time horizon of around 5 years and want to save tax as well. The rate of interest is fixed at the time of purchase for the whole tenure. Even in case of emergency you can avail loan against security of the NSC.
[Public Provident Fund (PPF)] :As against NSC, PPF offer better returns from taxation point of view as the interest on PPF account is fully exempt. Moreover the contribution to PPF account of yourself, your spouse or your children is eligible for deduction under Section 80C. However generally this has a maturity period of 15 years with the facility of partial withdrawal during currency of the tenure. Since the contribution to PPF is tax eligible under Section 80C and interest on it is tax free and with longer tenure of 15 years coupled with option to extend it by 5 years at a time, it offers an excellent avenue for accumulation of your retirement corpus or even for long term goal like education of marriage of your child for the people who do not want to take any risk as there is no risk in this investment product. The rate of interest is fixed every year and which is applicable on whole of the accumulated balance in the account.
- Insurance as Investment product
Insurance and investment are oxymoron. One should never mix the insurance needs and investment needs. In case you mix both the needs, you will neither get adequate insurance cover nor reasonable returns on your investments even to insulate you against inflation. For insurance needs, one should purchase pure term plans preferably an online term plan if the same is available in your city. Term plans are cheaper than any other insurance product as it only covers the risk and does not have any element of investment in it and is an ideal product to safeguard the life risk to ensure replacement of income in case of any eventuality. Online term plans are even cheaper as no agent is involved and thus the insurance company is able to save on distribution costs.
For investment needs one can invest in the debt fund or ELSS, tax saving FDs PPF, NSC etc depending on the time horizon of the goal and the ability to take risk. From taxation point of view, you can continue to avail the same tax benefits by buying a pure term plans and making investing in the above debt products as both these qualify for deduction under [Section 80C] ensuring higher insurance cover as well as better returns on the money invested.
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(The author is a CA, CS and CFP. He can be reached at jainbalwant at gmail.com and @jainbalwant)