Yesterday evening I receied a call from an old friend Arun. Arun knew I have interest in personal finance and financial wellbeing of people (though I do not have any formal education in the subject). He asked me he is interested in investing his money in the share market. He said he had exhausted all the tax saving instruments, so now don't know where to park his money. Though he have invested a lot of money in the tax saving instruments he is not satisfied with the returns. (good for him, because "Need is the Mother of Invention".)
Truly speaking Arun wasn't thinking about share market as an investment option, rather he found it as a biproduct while he was searching for more tax saving instruments. Arun was also asking me is there any more tax saving instrument available? Or how do I save my income tax.
Arun's condition represent the condition of most of the middle class employed population of India. As the tax filing due date approaches, people line up at life insurance companies offices or buy some Equity Linked Savings Schemes or life insurance products or pension plans or any other instruments which give income tax rebate. Some smart people do it in the beginning of the financial year itself, they do it systematically so as to avoid the last moment rush. The agents get most of their commission in the last month of tax due date selling such instruments.
After doing all this people brag to their colleagues and friends how much tax they saved. They are so happy with their achievement.
Charley Munger (Warren Buffett's right hand at Berkshire Hathway) says "Invert, always Invert."
So let's Invert,
Arun is saving taxes, that is governement must be losing taxes. Can it be true? I don't think so, why would government lose it's income to favor some life insurance company? I don't know the answer so lets Invert,
Suppose government is losing the tax money, then where the money is going? These tax saving instruments generally buys government bonds or bonds issued by governement undertakings or some other government approved bonds for investment purpose at a fix return rate which is around the same as doing bank fixed deposits.
Where is this money used?
Used as capital by government undertakings or for funding governemnt projects.
Why these projects are undertaken?
To provide the infrastructure for the growth of the nation.
How do the returns are generated?
Through the profit of the undertakings, for example toll collection on highways or express ways or sale of the electricity produced at hydroelectric powerstations etc.
Are you getting the point?
Government is not losing the tax money. Government is just getting a loan on a low interest rate when you buy a tax saving instrument. And if you pay the taxes without saving, then government is getting the money anyways.
So now we understood that we save tax or not, governemnt gets the money it wants. Government wants money to fund the projects and to maintain the armed forces ready for defence or for administrative expenses etc. How the government spends the money is not our topic of discussion here.
So the question still remains, whether it is good to save tax or simply pay it?
The answer is very simple, just look at how much your money will grow if you save in tax saving instruments and how much your money will grow in other investments vehicles minus the tax paid.
If you don't have any idea about how to grow your money more than tax saving instruments then tax saving instruments may be a good choice for you. But otherwise you may consider other options.
Let's see two examples to compare and understand when you save tax,
Suppose,
You have ₹ 1,00,000 as taxable income, you have to pay 10% tax on this income, that is ₹ 10,000. If there is a tax saving investment option which gives you the exemption of this 10% tax so you invest all this ₹ 1,00,000 in this instrument. This instrument gives you tax free return of 8% per year but has a lock in period of 5 years. Therefore after five years you are having ₹ 1,46,932 (calculated with cumulative interest of 8% per year) tax free in your hands.
In second condition,
You have ₹ 1,00,000 as taxable income, you have to pay 10% tax on this income, that is ₹ 10,000. You pay this tax and invest the remaining money, that is ₹ 90,000 in an investment instrument which gives you a tax free return of 12% per year but has a lock in period of 5 years. Therefore after five years you are having ₹ 1,58,610 (calculated with cumulative interest of 12% per year) tax free in your hands.
In the second condition you are having ₹ 11,678 extra at the end of the 5 year tenure.
Both are very typical examples in India. Anyone can get the returns stated in the second example with little efforts. (efforts like study and research)
Now suppose what will happen if you change the interest rate in second example to say 15% cumulative over 5 years with the starting sum of ₹ 90,000??
At the end of 5 years you will get ₹ 1,81,022, that is ₹ 34,090 extra compared to the first case. Stock market indices like NIFTY or SENSEX gives around the same returns over long term.
The difference among the above cases widens as the tenure increases.
If we replace 5 years by say 10 years the amounts will be-
1) ₹ 2,15,892
2) ₹ 2,79,526
3) ₹ 3,64,100
The difference between 1st and third condition is now around ₹ 1,48,000
If we do it for 30 years-
1) ₹ 10,06,265
2) ₹ 26,96,392
3) ₹ 59,59,059
Now the difference between first and third condition is a whooping ₹ 49,52,194.
(in the first condition, our starting amount is ₹ 1,00,000 while in second and third it is ₹ 90,000)
I hope, now we understand what a little difference in interest rate can do in the long run.
I am not recommending anything to you. The decision is up to you. My goal here is just to stimulate your mind for the good.
Hope I have achieved my goal of stimulating your mind. Think about it and take wiser decisions.
Do write your thoughts and insights on the subjects in the comments section. Better ask a question rather than staying in the darkness. Get some sunshine of knowledge.
See you soon.
Till then have a nice day..
Sumit
The POWER is when,
You use ODDS,
To get EVEN.
Truly speaking Arun wasn't thinking about share market as an investment option, rather he found it as a biproduct while he was searching for more tax saving instruments. Arun was also asking me is there any more tax saving instrument available? Or how do I save my income tax.
Arun's condition represent the condition of most of the middle class employed population of India. As the tax filing due date approaches, people line up at life insurance companies offices or buy some Equity Linked Savings Schemes or life insurance products or pension plans or any other instruments which give income tax rebate. Some smart people do it in the beginning of the financial year itself, they do it systematically so as to avoid the last moment rush. The agents get most of their commission in the last month of tax due date selling such instruments.
After doing all this people brag to their colleagues and friends how much tax they saved. They are so happy with their achievement.
Charley Munger (Warren Buffett's right hand at Berkshire Hathway) says "Invert, always Invert."
So let's Invert,
Arun is saving taxes, that is governement must be losing taxes. Can it be true? I don't think so, why would government lose it's income to favor some life insurance company? I don't know the answer so lets Invert,
Suppose government is losing the tax money, then where the money is going? These tax saving instruments generally buys government bonds or bonds issued by governement undertakings or some other government approved bonds for investment purpose at a fix return rate which is around the same as doing bank fixed deposits.
Where is this money used?
Used as capital by government undertakings or for funding governemnt projects.
Why these projects are undertaken?
To provide the infrastructure for the growth of the nation.
How do the returns are generated?
Through the profit of the undertakings, for example toll collection on highways or express ways or sale of the electricity produced at hydroelectric powerstations etc.
Are you getting the point?
Government is not losing the tax money. Government is just getting a loan on a low interest rate when you buy a tax saving instrument. And if you pay the taxes without saving, then government is getting the money anyways.
So now we understood that we save tax or not, governemnt gets the money it wants. Government wants money to fund the projects and to maintain the armed forces ready for defence or for administrative expenses etc. How the government spends the money is not our topic of discussion here.
So the question still remains, whether it is good to save tax or simply pay it?
The answer is very simple, just look at how much your money will grow if you save in tax saving instruments and how much your money will grow in other investments vehicles minus the tax paid.
If you don't have any idea about how to grow your money more than tax saving instruments then tax saving instruments may be a good choice for you. But otherwise you may consider other options.
Let's see two examples to compare and understand when you save tax,
Suppose,
You have ₹ 1,00,000 as taxable income, you have to pay 10% tax on this income, that is ₹ 10,000. If there is a tax saving investment option which gives you the exemption of this 10% tax so you invest all this ₹ 1,00,000 in this instrument. This instrument gives you tax free return of 8% per year but has a lock in period of 5 years. Therefore after five years you are having ₹ 1,46,932 (calculated with cumulative interest of 8% per year) tax free in your hands.
In second condition,
You have ₹ 1,00,000 as taxable income, you have to pay 10% tax on this income, that is ₹ 10,000. You pay this tax and invest the remaining money, that is ₹ 90,000 in an investment instrument which gives you a tax free return of 12% per year but has a lock in period of 5 years. Therefore after five years you are having ₹ 1,58,610 (calculated with cumulative interest of 12% per year) tax free in your hands.
In the second condition you are having ₹ 11,678 extra at the end of the 5 year tenure.
Both are very typical examples in India. Anyone can get the returns stated in the second example with little efforts. (efforts like study and research)
Now suppose what will happen if you change the interest rate in second example to say 15% cumulative over 5 years with the starting sum of ₹ 90,000??
At the end of 5 years you will get ₹ 1,81,022, that is ₹ 34,090 extra compared to the first case. Stock market indices like NIFTY or SENSEX gives around the same returns over long term.
The difference among the above cases widens as the tenure increases.
If we replace 5 years by say 10 years the amounts will be-
1) ₹ 2,15,892
2) ₹ 2,79,526
3) ₹ 3,64,100
The difference between 1st and third condition is now around ₹ 1,48,000
If we do it for 30 years-
1) ₹ 10,06,265
2) ₹ 26,96,392
3) ₹ 59,59,059
Now the difference between first and third condition is a whooping ₹ 49,52,194.
(in the first condition, our starting amount is ₹ 1,00,000 while in second and third it is ₹ 90,000)
I hope, now we understand what a little difference in interest rate can do in the long run.
I am not recommending anything to you. The decision is up to you. My goal here is just to stimulate your mind for the good.
Hope I have achieved my goal of stimulating your mind. Think about it and take wiser decisions.
Do write your thoughts and insights on the subjects in the comments section. Better ask a question rather than staying in the darkness. Get some sunshine of knowledge.
See you soon.
Till then have a nice day..
Sumit
The POWER is when,
You use ODDS,
To get EVEN.
