How to select the right financial products for tax planning and investment

Tax planning, risk, return, and duration are some key factors to consider for an investment. A large section of the taxpaying population chooses financial products solely from the tax planning perspective. However, financial planning is a broader umbrella, and many other factors influence the selection of the right financial product.

As you gear up for this year’s tax planning investments, here are a few other factors to help you make a more informed investment decision.

Also read: 8 Tax saving investment plans

1. Tax benefits

You may get a decent return from a financial product, but the maturity sum could be subject to income tax liability. Then there are products that may be taxable on maturity, but the investment made is eligible for tax deductions. So, proper tax planning is required in financial decisions.

Typically, financial products can have two or three areas where the question of taxability arises -

· Is the investment made during the year eligible for tax deduction?

· Is the interest or dividend earned on it tax-free?

· Is the maturity sum tax-free?

An investment like Public Provident Fund is ideal for tax planning, with tax benefits in all three situations, at least in the old tax regime. On the other hand, your equity investment is unlikely to derive any tax benefit. Investment in a five-year FD is tax deductible, but the interest earned on it is taxable income.

Always consider the tax implication of the investment product to understand how much net return you are likely to get. Accordingly, decide whether to invest in it or not.

2. Risk profile
 

For risk profiling, you must identify your risk appetite. The risk involved in a financial product must match your risk tolerance. For an orthodox investor, investments in stocks may seem risky. They may still invest and earn good returns in the long run, but each spell of market volatility will give them sleepless nights. 

Generally, the higher the risk in a product, the higher the potential return. On the other hand, for a given financial goal, the longer your investment horizon is, the less risk you need to take. So, depending on your risk profile and tax planning, you may choose a risk-free PPF investment for 15 years with Section 80C benefits or a high-risk equity mutual fund SIP for the same period.

3. Liquidity and lock-in period

If you have a large amount of money and the real estate market in your city looks promising, you can invest in a house property. It will also benefit you from a tax planning perspective. But this is not advisable if you need cash at short notice. The same goes for a financial product with a more extended lock-in period, such as PPF.

The liquidity of an investment is another critical factor. It is the ease of converting your investment into cash without a conversion loss. Real estate is an illiquid asset, and you may have to opt for a panic sale in an emergency. Stocks and mutual funds, on the other hand, are highly liquid. Thus, short and medium-term investments must be made in liquid assets, while you can choose products with a long lock-in period to meet long-term financial goals and tax planning objectives.

4. Expected returns

Return on a financial product can be in the form of interest, dividend, or value appreciation. Such increments must be considered after considering the income tax planning and implications. Another factor affecting investment return is the inflation rate. Your investment is profitable only if the investment is generating a return over and above the inflation rate. Inflation reduces the purchasing power of money, and it is only after considering inflation that you get an investment’s real rate of return.

Let's assume that your investment generates a return of 10%, the prevailing inflation rate is 6%, and the income tax on the return is 20%. Your profit after tax will be 8% [10% – (20% of 10%)]. Your actual rate of return is 8% – 6%, i.e. 2%. 

Thus, income tax and inflation are essential for calculating expected returns on investment.

5. Investment horizon

Choose financial products as per your investment horizon. Factors like liquidity, return, and your financial goals are linked to it. If you are looking at a short-term investment horizon, liquid and income-generating assets are ideal, while growth assets are better suited to long-term investment. For instance, a liquid mutual fund can be an excellent short-term investment with safe asset allocation and steady return. Equity, also liquid, is better for long-term wealth creation as it is prone to short-term uncertainty. PPF offers a steady return and tax planning advantage but is not suited for the short term due to the lock-in period.

Also read: What is the best age to achieve important financial milestones in life?

6. Investment ease and cost

Ease of investment, withdrawal, and sale is important because you devote time to the activity. Initiating, operating, and monitoring investments should be an effortless exercise. With your IDFC FIRST Bank Savings Account, investments can be made conveniently. Your internet and mobile banking profile act as a platform from which you can buy insurance, invest in deposits, and trade through a demat account in stocks and mutual funds. 

We have already mentioned how tax planning is essential in investment decisions. Apart from income tax, there are other costs involved in investment activities. If investing in market-linked products, check the entry and exit costs. For example, mutual funds may not have any entry cost, but there is a period-based or flat exit load on the redemption of units. Other investments like unit-linked insurance plans (ULIPs) also have entry costs.

7. Volatility

One of the factors that investors consider while choosing a particular stock is its beta coefficient. It measures the volatility of the stock relative to the market. Cautious investors avoid stocks with high beta as they are more volatile. Compared to government bonds and bank deposits, the share market, in general, has higher volatility. Depending on your risk appetite, you may choose financial products that are highly, moderately, or barely volatile. The government’s interest, policies, and tax planning can also affect product volatility. Other volatility indicators include the prevalent economic and geopolitical trends, both domestic and international.

8. Budget

A budget must consider unexpected emergencies, annual tax planning related investments, regular costs, future milestone expenses like marriage and education, etc. An investor must consider these while putting money into a financial product. Investors must decide how much of their surplus fund goes into investments. In the case of recurring investments like PPF or mutual fund SIP, long-term and regular fund availability must also be ensured.

Also read: The importance of budgeting tools and how to use them right

Conclusion

An IDFC FIRST Bank Savings Account can be your stepping stone to tax planning related investments and meticulously curated financial products. You can also integrate a demat and trading account and drive your financial and tax planning with your IDFC FIRST Bank Savings Account.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.