Tax-saving is an important part of financial planning. So, the primary purpose of your investments should be to achieve your financial goals and not just save taxes. There is no harm, if you get tax-saving as a complementary benefit along with your primary investments. Investment for just tax-saving can result in several anomalies in your approach towards achieving the financial goals.
Here are some important reasons why you should take a holistic investment approach and avoid investing just for tax-saving purposes.
Tax-saving investments come with several restrictions
When you invest in an instrument for tax-saving purposes, it comes with several restrictions, such as those related to the size of the investment, lock-in period, minuscule fixed return, etc. There is an upper investment ceiling of Rs 1.5 lakh per annum for investment in the tax-saving instrument every financial year. Different tax-saving instruments have different lock-in constraints. For example, ELSS has a lock-in of 3 years, ULIP has a lock-in of 5 years, tax-saving bank FDs have a lock-in of 5 years and so on.
Adhil Shetty, CEO, Bankbazaar, says, “Many Indians invest because it helps them save income tax. Some investments help you lower your income taxes under various sections of the Income Tax Act of 1961. Not all investments can get you tax breaks, but just a handful chosen by the government.”
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Tax-saving investments may not be adequate for all your financial goals
Tax-saving schemes are illiquid in the short term and come with a lock-in for the long term. On the other hand, there are several financial goals for which you require high liquidity and a short term. Therefore, you can’t consider a tax-saving scheme for short-term goals. You may not get many choices when investing in a tax-saving scheme keeping your financial goals in mind. On the other hand, there are vast options available under the non-tax-saving investment segment.
“The higher your income, the higher your taxes. A tax deduction is an amount you can subtract from income. This reduces your taxable income. Thus, your taxes get your total reduced too. Tax-saving investments solve the twin problems of investing as well as saving taxes,” Shetty explains.
You may get stuck on unnecessary long-term commitments
Some tax-saving instruments require a long-term commitment of regular investment while offering a very low return. For example, there are some traditional life insurance policies in which once you start investing, you can’t afford to opt out in the middle of the tenure and even if you stay invested for the entire tenure, you may end up getting a petty return. When it comes to availing the insurance cover, you must stay adequately insured but at the same time try to keep it separate from your investment needs.
Why settle for less, when you can earn a much higher return?
Your financial goal may require you to take high risks and earn a high return on your investments. Why settle for less by investing in tax-saving instruments when you can get a much higher return and achieve your financial goals by investing in a regular investment asset?
Regular investment options like equity mutual funds, debt funds, shares, SGB, bank FDs, liquid funds, etc. can allow you to maintain an adequate level of diversification to minimize the risk and earn a high return on your portfolio at the same time. On the other hand, you can’t diversify your portfolio adequately if you focus on investment for just tax-saving purposes.
What’s the right approach?
The right approach is to invest strictly in sync with your short and long-term financial goals. While investing, if any of the tax-saving investment fits your financial goal such that they offer you a good return, you are comfortable with their lock-in obligation and there is no better alternative to them, then you may invest in such a tax-saving instrument. You must keep your investing options flexible so that you could maximize the return or reduce the risk by making necessary adjustments in the investment portfolio.
