Dhirendra Kumar, CEO, Value Research

A few days ago, in a comment about the proposed mandatory corporate social responsibility (CSR) activities, Biocon founder Kiran Mazumdar-Shaw pointed out that when you make something compulsory, all you get is cosmetic actions rather than something that will actually have an effect. She also gave an interesting example drawn from her own experiences.

For many years now, the government has been giving substantial tax breaks for R&D activities. Yet, the real R&D activities in the corporate sector started only when the right combination of market conditions and a new breed of entrepreneurs came about. The tax breaks didn't actually produce the kind of behaviour that they were trying to incentivise. Instead, they just produced elaborate attempts to game the system by going through the motions of R&D, which is what mandatory CSR will also do.

However, that's not what I'm writing about today. What I'm writing about is that there's an exact counterpart of this phenomenon in tax-saving investments. Some of the worst investment decisions that individuals take is with their tax-saving investments. Deposits with long lock-ins that hardly pay anything more than inflation; insurance schemes that eat away most gains in agent commissions; ELSS mutual funds chosen with scant regard to performance track records - all these (and more) seem to be the norm when it comes to tax-saving investments.

Why does this happen? The basic reason is that there is a confusion of goals between saving tax and investment making. A typical investor makes this decision either in late March under the duress of meeting the deadline, or under intense selling pressure brought in by a salesman who's experienced at fudging tax benefits - which are not unique to his product - and the inherent characteristics of the products. At the end of the day, people make bad investment decisions, and if they ever realise it, they console themselves by saying that that at least they got tax benefits.

This duality of concerns - tax as well as investments - prevents clear-headed thinking about just exactly what one is getting out of an investment and whether the quantum of any disadvantages are actually worth the quantum of tax benefits being obtained. Investors should work on eliminating both these sources of bad decision-making - time pressure as well as not thinking about these investments as investments.

Eliminating time pressure is simple - just plan these investments as early in the year as possible - if you haven't done so, then this is the right time to do so. However, the other part needs a careful approach. These investments are investments and should not be made if you would not make them otherwise. For example, if you otherwise do not need to make investment in a fixed deposit but would rather invest in equity, then do so in your tax-saving investments as well. Or the opposite, if the need be.

Any investment has to first make sense as an investment, and only incidentally be a tax-saver.

Source: The Economic Times