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Look at the advertising splurge on television and you will know it is the season that insurance companies pull out all stops to get you to spend your 1.5 lakh in yet more insurance policies. Before you succumb to the hard sell this year as well and add a 10th policy to the already useless bag of policies, consider this year’s decision as a financial one. What does that mean? It means that you weigh costs and benefits, and take a rational decision, and not one that you take either because of a soppy advertisement or because you want to get rid of the insurance agent who is calling every 10 minutes. Don’t underestimate the leech-like attributes of agents—a friend called once in a panic because the agent was refusing to leave her home without the cheque; not knowing how to make him go away, she was considering writing a cheque just so he would go.

One way to deal with this is to look what you’re already doing and then use the extra amount needed to find a product to invest in. I believe that a large number of mass affluent tax-paying Indians don’t need to invest a single rupee to get the benefit of the 1.5 lakh-deduction. How? Check what your provident fund contribution adds up to. Then check the number that your home loan principal paid back for the year adds up to. If there is still some margin left to reach the 1.5 lakh number, use the Public Provident Fund (PPF) to soak up whatever is left of the limit.

Another way to look at this is to evaluate the choice set available for investment, and then choose one that gives the maximum bang for the buck. Let’s look at the basket of products that allow you to target a long-term corpus and come under the section 80C limit. From life insurance companies you can get endowment plans, unit-linked plans and pension plans. Mutual funds offer equity-linked savings schemes (ELSS) and notified pension plans. The National Pension System contributions get the tax shelter as well. Endowment plans give a return of between 2% and 6% per annum. So, 1 lakh invested 10 years ago will be worth 1.6 lakh at a 5% return per annum. The way these plans are sold confuse you as to your real rate of return, since returns are shown as absolute numbers spread across time. Typically, you will see returns shown as: in the 10th year you get 105% of premium; in the 11th year you get 40% of the first year premium; in the 12th year you get 30% of the first-year premium. The human brain picks up the large numbers such as 105%, 40% and 30%, and bites the bait. We forget to ask: what is the average annual return for this investment? If the agent selling the product won’t answer this question, you should know that the answer will prevent her from making this sale.

ELSS funds as a category have given an average return of 15.6% per annum over a 10-year period. So, 1 lakh invested 10 years ago will be 4.26 lakh today. The best fund would have turned your money into 7.15 lakh, and the worst would have got you 2.47 lakh. These are post-cost, post-tax returns. The two pension plans offered by the mutual fund industry also showcase the impact of long-term investing. India has just two notified pension plans that are eligible for the tax break and these have a 20-year track record. What does that record say? UTI Retirement Benefit Pension Fund is just over 20 years old, and 1 lakh invested 20 years ago in it is worth 8.25 lakh now, or a return rate of just over 11%. Franklin India Pension Fund is just about 18 years old and has turned 1 lakh into 10 lakh, or a return of 13.6% a year. Remember, these are not pure equity funds but have a large enough component of safer debt products. There is a tax on withdrawal when you turn 58 years old as applicable to a debt fund. For a person turning 58 in 2015, the post-tax return for a 10-year holding period is just over 11%, instead of just over 12% for the Templeton Fund and just over 10% for the UTI fund. This is because long-term capital gains in a debt fund are taxed at 20.6% of the profit after indexation. Even post-tax, the pension plans from mutual funds outrun the products on offer for long-term wealth creation coming from insurance endowment plans, PPF and Employees’ Provident Fund (EPF). Given the tax rules, it is better to stay with an ELSS fund for well over the lock-in period to save on the capital gains tax. But you need staying power for a product whose lock-in is just three years. If you can fight against the nudges to churn, then clearly ELSS funds work better in terms of both returns and tax.

But what if you had retired in the year that markets had tanked? It is this possibility of an adverse set of years when your retirement plan is due that you need to allocate money into different baskets. Going back to rule one: maximize your EPF and PPF; this forms the core of your portfolio. Then begin putting money away systematically into equity funds for long-term growth.

Don’t get into the trap sprung by insurance companies of heart-warming advertisements that bring value-destroying products into your portfolio.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at expenseaccount@livemint.com

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