Look beyond taxes
April is the best time for you to get started on an investment and tax-saving plan for the year. You have ample time to take stock of existing investments, plan new ones, create a tax-saving plan, and ensure your family has adequate liquidity and insurance coverage.
There’s often a tendency among many tax payers to leave these essential financial decisions till the end of the year. This is a folly. Hurried, poorly-thought financial decisions taken at the end of the year can have terrible consequences. Investing is done for many reasons, the primary ones being wealth creation and the achievement of financial goals. Let’s look at some reasons why you should not invest just to save taxes.
Insurance = investment?
A lot of Indians save taxes by buying life insurance. Often, life insurance is the only investment they make. There are several problems with this. Let’s look at them one by one. The primary role of a life insurance policy is to provide a sum assured which can financially support your dependents after your death. Often, people buy life covers that would be inadequate to support their family in the long term.
As a thumb-rule, the sum assured should be at least 10-20 times your current annual income. So if your current income is Rs 5 lakh, the sum assured should be Rs 50 lakh to Rs 1 crore. This will cause fewer financial problems for your dependents.
The easiest way to achieve this high level of coverage is by buying a term insurance plan, which has no investment benefits and whose premiums are lower in comparison to investment-linked policies. A low-cost life cover frees up your savings to be invested in other instruments that can generate high returns such as PPF or mutual funds.
Also, all tax-saving investments under Section 80C have lock-ins. For life insurance with investment benefits, the lock-ins are typically 3-5 years. Lock-ins create liquidity risk, especially for those who invest only via life insurance. In your moment of need, if all your money is invested in an insurance policy, you may face difficulties getting it back within the lock-in period. Premature surrender of life insurance policies leads to losses.
Next, those investing through life insurance policies often fail to check the annual rate of return on such products. One of the difficulties that long-term investors face through such products is a low rate of return. While ULIPs and mutual funds advertise a daily NAV which helps you track your fund value, traditional insurance policies don’t.
Sometimes, the annual rate of return on such policies works out to less than 4 per cent — which is what you get if you had left the money in your savings account. Therefore, investment via traditional insurance is not suited to wealth creation or even savings as the returns may fall below the rate of inflation, meaning that you have lost money instead of saving it.
There’s also the problem of poor life insurance persistency in India. Persistency ratio tracks the number of policies with an insurance company that are renewed after the first, second, third, fourth and fifth year. According to 2018 statistics released by the IRDAI, only 65 per cent policies were renewed after the first year persistency and just 34 per cent in the fifth.
The reasons may vary from lack of financial literacy to premature policy surrenders. The latter may also happen upon the realisation that a poorly-thought investment decision was taken and must be corrected. Therefore, due thought should be given to insurance purchase and it should ideally be separated from investment — especially for any persons who have financial dependents.
Investing should be led by clearly-defined goals — retirement, home down payment, children’s education, asset buying, foreign holiday or anything you aspire to. Each goal has two guiding lights: the time left for you to achieve it, and the funding it will require.
For example, you need to save Rs 50 lakh for your children’s college education due in 15 years. This helps you work backwards and calculate how you’re going to save for this goal, and which instrument is best suited to achieve it. This being a long-term goal, you can afford to take market risks, and, therefore, you decide to invest Rs 7,500 per month in a top-rated equity mutual fund SIP with a returns expectation of 15 per cent per annum. This investment plan could give you Rs 50.8 lakh in 15 years. But investing only to save taxes is akin to not having an investment goal at all. This may have repercussions on the selection of the right instrument, the rate of return it offers, the tax-efficiency, liquidity and costs of the investment, as well as the long-term state of your finances.
Panicky, last-minute decisions in March next year may lead you into making the above-mentioned mistakes. Your finances are one of the pillars of your life and the key to the fulfillment of your aspirations. Therefore, adequate time and thought should be given to financial planning.
Evaluate your insurance options — not just life insurance, but health too, for all your family members. Take stock of your liquidity. Ensure that you have an emergency fund worth at least three months’ worth of your current income to help you tide over unforeseen crises. Take stock of your investments. If you haven’t aligned your investments to life goals, you should do so now. Take the help of a financial planner if you need to. This would keep you from making potentially terrible decisions at the end of the financial year.
The writer is CEO of `BankBazaar.com`