3 High Cost Traps To Avoid While Investing

It is great to see the financial smartness movement pick up steam, especially since the last month. In the previous articles (1 and 2), we talked about how a systematic goal-based approach helps a woman take charge of finances. Putting such a system in place resolves the paradox in the lives of women - working hard both in their careers and at home, but still taking a backseat in financial matters.

While this is good stuff, it is important to be mindful of avoiding costs involved that could delay your financial goals by years, if not decades. Most of us get blind sighted by such numbers - investing is supposed to increase our corpus, so a small fee or commission is easy to miss, especially when pushed by aggressive salespeople.

#1. The Costly Impact Of Taxes

Someone once said that in life, three things are not avoidable - disease, death and taxes! While one cannot avoid taxes, it makes sense to invest in instruments that optimize tax. Some tips are:

• Invest the maximum possible in government schemes that give tax benefit under Section 80C under the EEE category: Exempt at time of investment, interest and redemption.

• Avoid schemes like National Saving Schemes whose gains are taxed upon redemption.

• When investing in Mutual Funds or Equities, be aware of Dividend Distribution Tax. Based on your tax bracket and invested asset, choose your investment mode wisely.

  • For someone in the 30%+ tax bracket (earning above 10 lakhs p.a.) a dividend scheme in debt funds might help as it is taxed lesser.

  • Equity funds have a DDT of 10% which is unavoidable. Here, growth schemes are better.

  • Choose a dividend scheme only if you have a need for liquidity (i.e. income is not sufficient to meet expenses).

It is important to mention Long Term Capital Gains (LTCG) announcement in the recent budget. A tax of 10% on long-term gains (with an exemption on the first one lakh) does not impact a vast majority of investors. A Rs one lakh gain, assuming historical 10% return, means a corpus of Rs 10 lakhs in equities. The average retail equity folio size as per AMFI is just about Rs 80,000! The message here is - keep investing for the long term, don’t worry about unavoidable taxes too much

#2. The Drain Of Commissions

Commissions cause perhaps the biggest erosion of wealth for investors. Brokers take hidden commissions of 1% to 1.5% on equity mutual funds. This adds up to about 40% over time.

To illustrate this better, let us take an example: Richa puts in SIP of Rs 10,000 per month into an equity mutual fund in the 'Direct Plan'. She ends up with Rs 7 crore, as compared to Sunita who invests in the 'Regular Plan' and ends up with 4.95 crores.

So Richa makes 40% more than Sunita in the long term.