You save and you invest. Yet you don’t make enough money. Where have you gone wrong? Savings or investment planning should be done on the basis of “effective” return that takes into account the cost and tax factors as well. These costs, such as transaction expenses, taxes and surcharges, weigh heavy on gross returns.

Equity investment

Equities generally give higher returns compared with other asset classes. But these are risky in the short term. However, if we consider a period of 28 years — from 1979 when the sensex was constituted — the index gave a compounded annual return of 20.38 per cent! However, the markets were full of murky trades before Sebi came into being in 1992. So, for our analysis, we took the figures from 1990 when the sensex touched the 1000-mark. From 1990 till October 9 this year, the sensex has given an annual compounded return of 18.53 per cent, the highest among all asset classes.

However, direct stock investments now entail costs in the form of 0.125 per cent security transaction tax and 1 per cent brokerage on purchase as well as on sale, transaction charge of 0.02 per cent, stamp duty of 0.01 per cent and 12.5 per cent service tax on brokerage. These add up to a total cost of 2.56 per cent, including purchase and sale of shares. But as there is no long-term capital gains tax on equity investment, it makes returns the least costly among the lot. Investment in stocks either through equity-linked saving schemes or ordinary diversified equity funds also gave a higher return than all other assets over a long period of time.

Debt funds

Unlike equity-oriented mutual funds, debt funds attract capital gains tax. However, the monthly income schemes or debt schemes don’t have entry loads, neither do they have any exit load. But a 14.03 per cent dividend distribution tax lowers the declared dividend of fund houses.

Property

Soaring property prices have attracted many people, but the lack of transparency in the property market and a wide difference in appreciation of capital values in different cities make it a risky affair. Besides, property investment comes with a high cost in the form of a 6 per cent stamp duty (on the property value) and 2 per cent registration fees. The National Housing Bank’s Residex keeps track of residential property prices in five major cities. The index shows a wide difference in price rise in different cities. Tax sops in home loans have made investment in properties lucrative. But the sale of a property attracts capital gains tax. This lowers the return quite a bit.

Assured income

The interest rate for fixed income assets at any given point of time will be determined by the lending rate in the market. The Reserve Bank allows banks to determine the interest rate on fixed deposits on their own from October 1995. Before that the rates were administered.

Following the relaxation, the market saw a great volatility in interest rates between 1996 and 2003. During this period, the deposit rate varied between 13 per cent (1996) and 5.25 per cent (2003) for a 3 to 5-year maturity.

Again between 2004 and July 2007, the deposit rates fluctuated between 5.5 per cent and 9.75 per cent.

But if you had invested Rs 1,000 in 1970 in a five-year bank fixed deposit and kept on reinvesting the maturity amount in another FD, you would have accumulated Rs 2,21,082 by now at a compounded annual return of 14.86 per cent. But then you would have to pay income tax on the interest accrued. Assuming that you are in the highest tax bracket, the effective return becomes 10.27 per cent only.

Interest rates on small savings instruments such as PPF, NSC and Kisan Vikas Patra are administered. The interest rate has been continually lowered from a high of 12 per cent to 8 per cent now. PPF has yielded a historical return of 11.50 per cent, which is tax-free.

With the liberalisation of the economy, interest rates will sooner or later align with global rates. The trend is downward. Besides, there will be more volatility in rates.

Bullion

Gold and silver are traditional investment avenues. But barring the last couple of years, returns have not been great. Since 1970, while gold has given a return of 6.08 per cent, silver yielded 6.49 per cent. Bullion investment should be considered for the short term as holding physical gold is costly. Trading in gold through exchange traded funds or commodity exchanges also attracts costs in the form of brokerage, transaction cost and stamp duty. Bullion investments are subject to capital gains tax.