Take a 1970s French scheme that “worked” in what are now seen as medieval times in finance. Add a government department desperate for a new idea, having botched up the retail part of the financial market by creating situations where regulators fight and investors get swindled. And you get the proposed Rajiv Gandhi Equity Savings Scheme (RGESS) that gives a tax break to small investors who invest directly in equity. The scheme will give first time equity investors who earn upto Rs10 lakh a year, that is Rs83,333 a month, or a post-PF and tax amount of about Rs50,000 a month, a 50% deduction on investment up to Rs50,000 directly into stocks.
I find four things of urgent concern with this scheme and what it is trying to do. One, the scheme encourages those least able to take risk to go directly to the market. After meeting household and other expenses, a person getting about Rs50,000 in hand each month is going to have an investible surplus of no more than Rs5,000 a month—a really small amount for direct equity investing. Small ticket investing directly in stocks is high risk as it exposes the money to the performance of one or two stocks. The possibility of a large price change—both up or down—is much higher. Typically for the small investor the mutual fund route is recommended for exposing the money to equity, where a fund manager does the stock selection and the downside is protected to a certain extent. Pedigreed funds with more than 10 years of history in India have done well by retail investors, returning over 20% year-on-year (y-o-y) for a 10-year period. Direct stock investing for small ticket retail investor is a high-risk road, one that the government should not endorse.
Two, there is ample scope of “fixing” the system. Somebody will have to create a list of “approved securities” for this product and we have enough experience that when a government department draws up such a list what can go wrong. There are fears that the tax break will finally go to investment in PSU stocks to try and kill two birds with one stone. The retail money will not just go to the market, but will fund the government-owned companies that otherwise are finding few buyers.
Three, the lock-in of three years is too short a holding period for equity. The argument coming out of North Block is looking at data of performance over 10 years to show a 30% y-o-y growth in index value over the period, but looks at a lock-in of just three years. Investors will end up buying high and selling low with this lock-in. Lock-in for equity schemes needs to be at least five years. Four, the scheme allows for trading during the lock-in period. This means that you buy stock A from the approved list and then switch to stock B three months later from the same list and then to stock C. Bye bye, long term investing, hello churning! The only part of the market to benefit will be the stock brokers who will take the really small investor’s money and churn heavily.
Tax breaks have been used successfully globally to nudge skittish investors towards risky equity and if we are looking west, why not look further and go across the Atlantic. The US has used tax breaks to get people to invest in equity using the tax-friendly Individual Retirement Account (IRA) and more than a quarter of the retirement wealth is now held through this vehicle. This gives a person an option to invest in equity, directly or though funds and the more conservative bond fund options are there as well. But the holding period is longer and product choice wider. To get the small investor interested in equity is a good idea, but do we need to introduce a new product when we have some good products on offer? For long-term equity investing we already have the New Pension System (NPS) that is a cheap and efficient way to target long-term capital accumulation. The mutual funds have an existing product called the Equity-Linked Saving Scheme (ELSS) that can be used for the non-retirement seeking investors. 10-year performance shows a return of over 20% per annum for the top 10 schemes in the ELSS category.
Of course, the real way to get a thick never ending pipeline of retail funds would be to clean up the retail market and take away the conflict between competing products that have different incentive structures. Ask Reserve Bank of India to control its swinging relationship mangers as they swindle small investors by selling unsuitable products. What the small investor really needs is a market place he can trust. Not this hare-brained scheme. It should be buried before it is born. Or we’ll have another Ulip-like monster to deal with in a few years.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at firstname.lastname@example.org
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