Why You Should Not Invest Just For The Sake of Tax Deduction

When the months of February and March come around there is a frantic race to invest in various instruments that will provide tax benefits but if you invest just for the sake of saving on taxes there is one thing you just missed on. That one this is the return from the investment. No one likes paying taxes but that is no reason to make rash decisions with your money, especially when it gets invested in an instrument with a lock-in period because once committed, they cannot be withdrawn till the lock-in period get over.  For example let’s take the example of investments in a tax saving fixed deposit vs a tax saving mutual fund. With one you get a safe environment for the money but not a particularly attractive interest rate and a 5 year lock-in. With the other you get an unsafe environment but also the chance for getting higher returns and a shorter lock-in period. Weighing the option is everything when it comes to tax deductions.

Tax Saving Mutual Fund

Why not to invest just for tax

Since weighing the options quintessential to proper investment planning, let’s take a look at what happens when this step is actually ignored.

Investing in the wrong instrument

Let’s say you need to invest another Rs. 8,000 before the financial year is over and you need that money for something else as well. You decide to take a term insurance policy of about Rs. 1 crore but you just did something wrong. You invested in an instrument that provides tax benefits but no returns if you survive the policy. Even if the investment was made in a return of premium policy, there was a chance that there would be some maturity benefit. But not with a term insurance.

Minimal return

Let’s say you wanted returns and tax saving and you ended up investing Rs. 1 lakh in a tax saving fixed deposit. You just made a bit of a mistake because of you had invested that money in a tax saving mutual fund or ELSS, you might have gotten better returns.

Not a sustainable investment

Let’s assume that you weighed your options and decided to invest in an ELSS or tax saving mutual fund. You decide to invest in lump sums and the amount you invest is Rs. 60,000 per year. You pay the first years Rs. 60 thousand but the next year you don’t have that kind of money but there is nothing that can be done because it needs to be paid. You just made an investment that is not sustainable.

Wasted investment

Let’s say you wish to invest in a health insurance policy and are looking for one thing and one thing only; and that is tax savings. You take a policy and one day fall ill and decide to you that policy but when you go to claim the benefits you realise that you have taken inadequate cover or a policy that is actually a co-pay policy where you have to pay part of the bill. You just wasted money on an investment that does not serve you at all.

Investment that earned loses instead of returns

This is something that can happen with tax saving investments that have a link to the markets like tax saving mutual fund, ULIPS and ELSS. You invest thinking you’ll get tax savings but realise that you invested without looking and now the investment is actually generating more losses than returns and you cannot sustain such losses. You just wasted money and forced yourself into a financial corner.

An investment made for tax saving can be anything you want. It can be a life insurance policy or a tax saving mutual fund or even a fixed deposit. But the thing you MUST do is, first understand what you are looking at and what you are buying!