Are taxes and inflation eating your investment?

Are taxes & inflation eating your investments?

by Rajeev Pathak

Photo by Tara Winstead from Pexels

Any investment is made with the objective of getting high returns in the long term. But sometimes, we end up with a poor return with a tax burden and inflationary impact. In this post, we will discuss, Are taxes and inflation eating your investments?

            Before making a decision to invest in any asset class, we should ask ourselves how much return we should get out of it. In practice, it does not happen, we invest in certain instruments as traditionally, we have been investing in them.  Before we discuss ‘how much' of return, we should ask ourselves why?

Why do we want to invest? 

Generally, we invest to achieve a certain financial goal like to make a corpus of a certain amount (say, to become crorepati) by a certain date. Why…question still continues…. to meet the expenses of children’s education or to bear the expenses of own or children’s marriage or to buy a house or just as a retirement comfort.

Let us take an example.  You want your son or daughter to join a professional course after 5 years. The cost of such a course today is supposed to be 5 lacs. Will it remain the same after 5 years. No, it may increase with the rising inflation.  The average inflation rate in our country (CPI) has been as under during the last five years:

Inflation is the culprit No.1:

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Year             Inflation (%)
            2016             5.22
            2015             5.88
            2014             6.37
            2013             10.92
            2012             9.30   
          

(Source: inflation. EU)

Based on the above data average inflation rate for the last 5 year period comes to 7.53%. So, it is certain that the cost of higher education is going to increase by 7% (approx.) in the next 5 years. The same will be the fate of cost of our other dreams like house or marriage or cost of living after retirement.

Tax Liability is the villain No.2:

Next comes the tax liability. Interest income is presently taxable and added to our income. Income tax is charged as per slab rate (Presently, maximum 30% plus applicable cess for the AY 2017-18) on taxable income.
        

So, we learn from the above example that it is a must get a minimum return of 9.10% (Average Inflation Rate + Tax Rate) to make our investment economically viable. You can consider any financial instrument, if you are earning an annual return of less than 9.10%, you are making losses on your investment and your decision need a review as your savings will be short of the cost of your goal.

Then, how much return we should get. I am of the considered view that our investment must grow minimum at the rate of our GDP. The Indian economy has grown at an average rate of 6.08% since 1951, the year when we started economic planning. Though, there were years of turbulence when the country’s growth rate was negative (source: tradingeconomics.com). So, there is no reason our investment should not grow at the rate of GDP.                                      

Is it possible to make our investment profitable? Sounds unlikely, No, it is possible.
    

• First of all, we should find an instrument where returns have grown at the rate of equal or more to GDP,

• Secondly, we must find an instrument where the growth rate has beaten the  rate of inflation and

• Thirdly, we should find an instrument where our returns are tax-free.

Investments in Mutual Funds are the answer to all the above three conditions. But, not all the Schemes of Mutual Funds, there also you will find leaders & laggards. 

We have to select the right scheme to achieve our financial goals. More so, a scheme that suits our financial limitations & aspirations. We will discuss specific schemes in some other pieces of writings. Till then, happy investing.

boirajeev@gmail.com

*Past performance may or may not be sustained in the future.

 **Mutual Fund investments are subject to market risks, read all scheme related documents carefully.