Our first reminder on taxes and their deduction comes with an email from the payroll department or our tax advisor/agent: It’s time to submit your investment proof for tax deduction. We scramble to get the task completed and when the speed of the task is more important than its appropriateness, the easiest option is always the one that requires no thought.
We all tend to issue cheques for the same schemes we invested last year and at times even the same amounts and get the agent to execute the same. We are just too happy to get the receipt and pass it on to the payroll department for tax deduction. Thus, tax saving is done!
Most of us approach tax saving investments this way as what is more important is that the tax saving was done.
This situation highlights few cognitive biases that we fall prey to. One is the “Bandwagon Effect”. The tendency to do things because others do it the same way. This bias pushes our decision to invest in tax saving instruments to a time when it becomes too late to objectively evaluate the options.
The second cognitive bias is called the “Sunk Cost effect” also known as the “Concorde effect” sometimes. The British and French governments continued to fund the joint development of the Concorde even though it became apparent that there was no economic case for the aircraft. Similarly, we tend to continue with many investment schemes well after it becomes apparent that they are not wise choices for us.
The market has tax saving options; the most common ones being PPF, life insurance schemes, NSC and now 5-year bank deposits of various scheduled banks. Among these schemes, NSC has been popular over the years while the 5-year bank deposits are the new entrants among this set.
In an interesting survey that we commissioned to get an insight into tax saving habits and practices of individual investors, we noticed that an astonishing two out of three people surveyed believed that NSC was a totally tax-free instrument and about one in two people felt that bank deposits were totally tax-free. This information is factually incorrect!
It is unfortunate that some investors will realise that their incomes or capital appreciation will be taxed but it will be a realisation too late.
Most people are unaware of the various instruments and their benefits and drawbacks when it comes to saving taxes. Most people believe that equity is an investment that has great long-term wealth generating potential, but they miss the opportunity to invest in ELSS (Equity linked savings schemes) which can help build long term wealth and are among the few tax saving instruments that promise tax savings on initial contribution, on dividends as well as on maturity as per current laws. In that sense, it is beneficial to invest in ELSS than some of the fixed income schemes in the market.
ELSS is tax-free under Section 80 C of the Income Tax Act and provides potential to grow investments and save taxes better than some other traditional instruments. It still may not be late to enter this scheme, after all the year well begun is half done!
The author is Managing Director of Standard Chartered Mutual Fund.