Educated masses of the 21st century have understood the importance of growing their hard-earned money. Most public-sector enterprises and almost all private sector companies have removed the pension policy system. This entire situation has given rise to the problem of financial instability faced by the employed class of people.
Gone were the days when the Indian population was solely dependent on fixed deposits in public sector banks as an investment option. Several new and lucrative investment opportunities are now available in the country. However, most of these returns on investments are taxed by the government (Starting from Rs.2.5 lakh - Rs.5 lakhs-5% tax on annual income). It is of utmost importance for the educated masses to invest wisely in a well-structured portfolio favouring both taxed and non-taxed instruments as per an individual’s demand and time monetary needs.
Smart investor of today needs to be alert to the following to make sure that they’re choosing the right instruments and are reaping the right benefits of their hard-earned money:
Investing in an instrument that doesn't have tax efficiency will not help you build your capital. An attractive guaranteed return that is taxable would not be a wise investment.
A smart investment is where we have sufficient alpha over and above post-tax returns. The higher the alpha better is the wealth creation.
The tax-free options are not available in primary markets i.e. direct subscription, but some instruments are tax efficient which should be considered by investors falling in the highest tax slab. Real wealth creation happens by choosing the right asset class giving higher post tax returns and MFs, Equity, Insurance and other products offer higher tax efficiency.
Some of the options that could be considered against taxable instruments are as follows:
1. Fixed Maturity Plans (FMPs) are closed-end debt funds that have a fixed maturity period. Unlike other open-ended debt funds, these are not available for subscription continuously. The fund house comes up with a New Fund Offer (NFO) which has an opening date and a closing date. You can invest in an NFO only when it is available for subscription. FMPs are useful especially for those in the higher income-tax bracket, since they get to avail of much lower tax rates, as opposed to instruments like FDs, due to indexation benefit in long-term capital gains. To be able to take the benefit of indexation on long term capital gains tax, the investors need to stay invested for at least three years.
2. Debt Funds are considered by many as coming closest to FDs in terms of risk. However, they have a slight advantage in terms of securing returns ranging from 7-9% as compared to 6-8% in case of Fixed Deposits. Plus they offer other benefits including higher liquidity and, in some cases, even SIP routes. The biggest plus is the taxation as instruments like FDs, over a long-term period, are taxed as per tax slab as opposed to a taxation of 20% for Debt Funds, if an investor remains invested for 3 years or more. Additionally, they carry indexation benefits, meaning tax payments are done after adjusting inflation, which is a big plus.
3. Insurance products with guaranteed returns:
a. There are products available today that guarantee your returns and pay you higher interest rates that bank FDs and ensure tax-free income for many years. They have the potential to go across generations; act as your first/second pension, and much more. (For more details on the same, read our blog: “Three S (Stability, Safety and Security) Investment Plan that transforms lives!”
b. Unit Linked Insurance Plans: ULIPs provide both the opportunity to build wealth and the assurance of financial protection in the event of a tragedy. The long-term aspect of the product enables one to accumulate money for one's life goals, like marriage, property and children's cost of education. One receives his current fund value of one’s investment at the conclusion of the policy period. The nominee is entitled to the due in case of any misfortune in case the situation arises.
4. Target Maturity Funds mostly invest in high-quality fixed income instruments like government securities, PSU Bonds, state development loads, etc. These offer tax efficient returns as compared to traditional investment avenues. In TMPs, the long term capital gains tax on investments held for more than 3 years is 20% post indexation (adjusting the initial investment for inflation*) as compared to 30% in case of traditional investment avenues (for investors falling in the highest tax bracket). Moreover, it has liquidity all through the investment unlike FMP where it being close ended the funds are realised on maturity.