6 Tax Fundamentals Every Investor Should Know

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Most of us want to save taxes but end up making poor decisions on your investments while you do so. A few simple tips will ensure you don’t have to compromise on investing well, to save taxes.

Spending is not investing: You may think you have saved tax by claiming deduction on medical expenses, your child’s education or your EMI on home loan. But you really haven’t invested. The deduction under Section 80C largely deals with investments that help you save tax and build a corpus for your future. In your focus on saving tax today for your expenditure, do not lose sight of investing for your future.

Why tax-saving investments matter:  Yet another reason why you should be focusing on investments rather than expenses to save tax is the higher yield you get on your investments because of the tax saved. For example, in a small savings scheme like NSC gave you 7.9% interest, and if you are in the 30% tax bracket, the yield on this investment is a whopping 16%. This is because you saved 30% of cash outflow from tax, had you not invested.

Delaying does not help: For most, the wakeup call for fulfilling their tax-saving needs comes only the due date for submitting it to the employer nears. Starting your tax-saving investments early on helps in multiple ways: one, you will not rush into poor products and will have time to choose what you want; two, by investing early, you allow compounding to work longer; three, it allows your employer to deduct taxes in a phased manner than deducting it all at the end.

If you cannot do this, try to invest as and when you have surplus. You can invest small sums in PPF or invest them in tax-saving funds.

Goal-based tax investments: Most of us do not miss the insurance premium to be paid very year. But how many make such regular investments? It is usually adhoc. You can ensure that you make a habit of the other tax-saving investments by earmarking them for your child’s education or wedding or any other big expense. Products such as NSC, PPF, ULIP tax-saving mutual funds can be ear-marked for specific purposes. This will lend a good objective to your savings.

Don’t ignore the other investing options: In your fixation to save maximum taxes, you may give good investment products such as bonds, stocks or mutual funds the short shrift. While many of these options may not provide you the 80C benefit, remember that they can provide superior returns over the long term. It’s not what you make but what you keep that matters. A bank deposit may offer 9 per cent returns but net of a tax (assuming 30 per cent), your returns are 6.3 per cent. That does not even beat inflation, which means you have negative returns. A diversified equity fund or a stock may not give you any upfront tax deduction but offers superior returns and low tax in the long term.

Holding longer also provides other tax benefits: Even as you get some tax benefits for investing under Section 80C, there are benefits to holding for longer periods even in investments that do not qualify under Section 80C. For example, holding debt funds for 3 years or more makes you significantly more tax efficient than holding deposits. This is true for gold, property (2 years) or bonds (1 year).

Similarly, investing in equities/equity funds for over 1 years gives you far more tax leeway than other asset classes.

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2 thoughts on “6 Tax Fundamentals Every Investor Should Know”

  1. Hi

    Could you pls help me understand this statement.

    “For example, in a small savings scheme like NSC gave you 7.9% interest, and if you are in the 30% tax bracket, the yield on this investment is a whopping 16%. This is because you saved 30% of cash outflow from tax, had you not invested.”

    I am not sure I understand how yield is 16%. Could you pls help me understand it? Thank you.

    1. Hello Sir, Yield is the return on yoru actual investment value. If you invest for example Rs 1 lakh in NSC and you are in 30% tax bracket, your ‘real cash outflow in that year of investment is Rs 70,000 (Rs lakh minus the cash outflow of 30k saved in tax through 80C). So in year zero the net cash outflow in 70k. If we take this and calculate the returns for the NSC over its period, including the compounding, the returns wok out to 16%. This high returns comes because the base (the first investment) being low, considering the tax saved. Hope this clarifies.
      Thanks, Vidya

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