What are some mistakes to avoid while choosing tax saving investments?
There are plethora of tax saving options available (Most of the tax saving options in India are under Section 80C). However, very few people bother to understand how these investments works and what suits them. This leads to people getting drawn towards investments which are pitched by friendly neighborhood uncles, bank RMs and financial advisers with vested interests.
Before long, you get sucked in an inefficient product which may prove detrimental to long term financial health.
(Meanwhile, one can do well to understand difference between investment and expense. For instance, a home may be an investment but home loan is an expense which can help you save taxes. So is premium payment for you term insurance cover – it is an expense, not an investment)
3 Mistakes to avoid while choosing tax saving investments
(Assumes Indian context, but can be true elsewhere too!)
1 – Having tax saving as the only objective
It is not uncommon to see people buying financial products or investing or making a purchase just to save taxes. This forms a fertile hunting ground for people looking to sell different products – like endowment plans or ULIPs. At the same time, it is not uncommon to see people “investing” in home primarily to save taxes on home loan!
Not understanding about returns and bothering only about tax saving is a recipe for making others rich at your own cost.
Before you invest, it can be a good idea to have good enough reasons for investing (apart from tax saving)
The positive thing is that if you buy term insurance or health insurance to save taxes, you may unintentionally create a safety net, which can be helpful.
2 – Not understanding risk, returns and getting carried away by sales pitch
Some instruments have risk associated (e.g. ELSS, though have given good returns, has a risk associated). Many insurance policies (endowment plans/ ULIPs) are also susceptible to markets linked risk. In case of assured returns, most of these instruments won’t even beat a bank fixed deposit.
Whatever the sales pitch (especially in insurance plans and real estate investments!) proclaim, it can be a good idea to be aware of the risk and returns and not take everything at its face value.
There are countless stories of people who fell for these sales pitch and are unable to move out because of financial commitment and potential losses. Avoid one of these stories being yours!
3 – Underestimating the commitment needed over a period of time
Some investments require commitment over a period of time. If you are buying an insurance policy, you’ll need to pay premium every year. If you are investing in PPF you need to make (at least a small) investment every year. In case of home loan, it needs to be repaid over a period of several years. For NPS, this lock-in period it till retirement (premature withdrawals come with several restrictions!)
Nothing wrong in selecting products with high lock-in if it suits your needs. But understand the financial commitment you’ll need over a period of time while evaluating your investments – especially if you need to put in a lot of money every year.
For instance, you may not be mentally (and financially) ready to commit tens of thousands (or lacs) of rupees every year to renew your endowment plans or pay off your home loan EMIs, though you may have committed for that.
To sum up,
Before jumping to any investment, sit back, relax and evaluate few things.Be aware of how that investment works, what are risks and returns, what is the lock-in and what kind of commitment do you need.
Then decide where to invest. And don’t leave it for the end of financial year.
Have anything else in mind about mistakes to avoid in tax saving investments? Do share!