Is it difficult to become a millionaire? I am not talking about dollars but Indian Rupees. If you save every year a lakh of rupee and invest that amount in such a way that it earns a return of 8% every year, you will become a rupee millionaire (Rs.10.63 Lakhs actually) in about 8 years. If you extend this calculation further, how much you would have accumulated had you started investing at age 30 and continued upto retirement at 58 years? The answer is Rs.1.04 Crores. Astonished? It simply is the power of compounding which makes you a millionaire many times if you save Rs.1 Lakh every year and invest the same at 8% year on year. Any salary earner would know the significance of the figure Rs.1 Lakh. It’s the exemption available to him/her under the famed Section 80C of the Income Tax Act. Which are the financial instruments one can invest to avail the exemption under the section 80C? The list is fairly long: At the top of the heap is the amount employee contributes towards provident fund account. Every employee who is covered under the Provident Fund regulation is required to contribute 12% of basic salary to her PF account and her employer would also contribute a similar amount (i.e., another 12% of basic salary) into the PF account. The next most popular savings instrument is life insurance policy. Though I would not advice some one to club insurance and investment, there are millions who do it (traditional/ULIP etc). Equity Linked Saving Scheme (ELSS) is gaining popularity now owing to the kind of returns given by some of the funds. Inherently, investing in equity, directly or through mutual funds has high risk, that is loss of capital. If the investment period is long enough, the risk would come down and it might be possible for the investor to earn a higher risk adjusted return.
Other savings instruments/investment options which are eligible for exemption are NSC, PPF, 5-year bank fixed deposits, infrastructure bonds etc.
The purpose of writing this write-up is not as much about the selection of instruments but about the fact why many salary earners do not become crorepatis or multi-crorepatis by the time they are ready for retirement? In the above example we have seen that even at 8% annual return, some one can become a crorepati, if she invests Rs.1 Lakh every year. And a salary earner definitely maximises the savings under the section 80C by investing either compulsorily or voluntarily. What happens then? Answer lies in many issues which bother your savings/investment habits. Salary earner’s main concern seems to maximise the tax exemption through savings without any long term goal being set. This leads to leakages from the corpus once the lock-in period is over. Lock in period is as low as 3 years in some cases and a salary earner would withdraw the capital to reinvest than adding to the corpus. This short sighted view on savings and investments hinders the growth of the corpus. In the case of statutory savings like provident fund also, there are withdrawal options available. For example, one can withdraw a certain portion of the PF corpus for the needs like marriage, education, purchase of plot, construction of house property, medical expenses etc. thereby reducing the corpus. Some times the wrong choice of instruments also inhibits the growth of corpus. It’s a fact that many traditional insurance products like endowment plans and money back policies give a low return and do not provide adequate risk cover. A short sighted view that aims only at maximising tax exemption actually does not serve the purpose. If you are investing in ELSS and select dividend payout option, then also, the corpus would be lessened because the dividend paid out is used for purposes other than savings/investment. One should have a clear goal / purpose for savings and investment and getting the exemption should really be a second priority.
Finally, to end this discussion, here is a question for you.
If you are in the highest tax bracket of 30%, what’s the amount of tax you save if you invest Rs.1 Lakh in the instruments listed under section 80C?
Answer is Rs.30,000/-.
Now, if you start investing Rs.30,000/- every year when you are aged 30 years upto the retirement age of 58 years, any guess what’s the corpus created if your investment earns a return of 13% annually?
Answer is Rs.68.38 Lakhs
Incidentally, NSE Nifty Index has given a return of 13% per annum since it’s inception!
Narendra K N
CERTIFIED FINANCIAL PLANNERCM
