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Equities have the edge to beat inflation, Tax in long run
Published On , 19 May 2017 By Times Of India
Traditionally Indians invested in bank fixed deposits (FDs), gold, PPFs for long term wealth creation. They also bought, quite wrongly, insurance policies thinking them to be investments rather than protection. And those who could afford, in addition to these financial instruments, also bought real estate. Things, however, are changing. New research shows that several of the traditional investment products that Indian bought or invested in, actually destroy wealth in real terms, financial planners and advisors say. The question naturally is how.
THE INFLATION BEAST
For an answer one needs to understand how inflation affects prices and returns. Suppose you buy a product today for Rs 100 and the rate of inflation is 5% per year. So after a year the same product will cost you Rs 105. Now suppose you keep money in savings bank (SB) account and get 4% rate of interest. After a year, your Rs 100 in the SB account will fetch you Rs 104. Now if you want to again buy the same product that you bought last year for Rs 100, you will have to pay Rs 105 but you only have Rs 104 in your SB account. You have to arrange an extra rupee to buy this.
REAL WEALTH CREATION
So here by keeping your money in the SB account, which gives you a rate of interest that is less than the rate of inflation, your have destroyed real wealth by Re 1. Here again, if your total SB interest income is more than Rs 10,000 per year, you will also pay tax on that. So your post-tax, post-inflation total wealth could be about Rs 103.60 or less.Thus while the inflation is 5%, your post-tax return is 3.6% or less.
The simple rule of investing in financial assets, according to financial planners and advisors, is that your post tax return should be more than the rate of inflation. Then only you can create wealth in real terms. Most traditional financial products fail to meet this simple criteria. Historical data, however, show that by investing in equities and good Equity mutual fund schemes, you can beat the inflation beast easily.
LONG TERM STORY
Creating large wealth in the short term, in 2, 3 or 5 years is very difficult. On the other hand, creating wealth over 15, 20 or 25 years, by investing in equities and good Equity mutual fund schemes is not that difficult. Consider the fact that in the last 25 years, the sensex has given a return of 9%, compared to gold (8.9%) and bank FDs (8.7%) while one of the good Equity mutual fund schemes has given 12.2% return. Returns may look quite comparable, but remember in this case returns from gold and bank FDs attract income tax while returns from equities and Equity funds is completely tax free.
THE SIP EDGE
By investing Rs 10,000 per month through a systematic investment plan (SIP) in a good Equity fund for 25 years, you can have a portfolio of about Rs 1.9 crore. In comparison, if you invest the same amount in an RD at 6% rate of interest, you’ll have about Rs 69.7 lakh.
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