Let’s understand the key considerations while investing and we will then take each of them one by one:
- What amount of risk you can take?
- What is your investment horizon?
- What is post tax return?
We will start from the third one. What is the impact of tax on different instruments we can invest money.
- So say hypothetically one instrument offers return of 10% annually which is taxable and another offers 8% which is tax free.
- If your effective tax rate is 25%, then the post tax return in first is 7.5% which is lower as compared to 8% in second option. But if your effective tax rate is 15%; then first option offers returns higher.
Below table depicts the four scenarios-
|Instrument 1||Instrument 2|
|Return||10% p.a.||8% p.a.|
|Tax Treatment of returns||Taxable||Tax free|
|Scenario-1- 25% Tax||7.5% p.a.||8% p.a.|
|Scenario-2-15% Tax||8.5% p.a.||8% p.a.|
The key point is while looking at the return of any instrument you must look into post tax return of the instrument in terms of instrument and your tax bracket.