Finally, equity is also on the radar of tax saving instruments. In budget of Fy2012, Finance Minister Pranab Mukherjee allowed investors to invest up to Rs 50,000 in equity directly with a lock in period of three years. By doing this investors can save taxes on 50% of this amount, i.e. taxes on Rs 25,000. If you fall in 20% tax bracket, your immediate saving is Rs 5,000. This means you got a return of 20% immediately just by clicking the button of the mouse and buying any tom, dick, and harry equity.
Sounds good, isn't it. This is Rajiv Gandhi equity scheme for you presented by Finance Minister of India.
The scheme is certainly good as it will motivate more retail investors to use stock market for higher returns. Indian stock market has very little penetration in the retail market. As an estimate, less than 2% people invest in equity despite India being an emerging economy.
The other advantage it will have is creating awareness in people about overall financial planning.
The concern is that it will lead to much speculative trade in the market. Most of the taxpayers do their tax planning just before the end of financial year. The market may experience spurt in demand of stocks which can take prices to unsustainable level. From this point, the prices may crash after the tax season is over. This fluctuation itself will kill chance to make money out of stock investment.
Remember that investing in bonds, mutual, funds, tax saving instruments (other than equity) do not pose much risk to your capital even when you select the investment at the last moment. You may get slightly lower return compared to those who have planned in advance. The case of equity is different. Here, the risk to lose capital is very high if there is no plan and research before buying.
Additionally, there is always the fear of mis-selling and vested interest brokers trying to promote volatile or illiquid stocks to fleece money from investors.
A note on lock in period
The induction of lock-in period of three years has pros and cons both. Introducing a lock in period in equity investment will prevent investors from transacting at right time to either maximize the profit or minimize the loss.
However, at the same time, removing lock-in period will bring more speculation in the market. Many tax payers will like to sell immediately after availing the tax benefit.
What should investors do?
Investors, unlike in cases of mutual funds, PPF, bonds, cannot rely solely on brokers for sound advice. While most of the brokers do try to provide sound suggestion, there are many who can take advantage of the situation. Irrespective of brokers' advise, investors should do some research on their own to find out the right investment.
Second, this should be planned well in advance. Do not rush to buy in the last moment. Keep an eye on few sound stocks and buy when the time is favourable and stock is available at reasonable valuation. This is easier said than done though. Keeping track of few stocks is easy. Select few sound companies and keep a watch.
Last but not the least; find a reliable investment adviser or financial planner who can suggest you right investment.
Does the scheme require changes?
The scheme is still evolving and hence it will be premature to suggest any changes before the complete picture emerges. However, there is confusion on what is meant by investing in equity directly. Does this means buying stocks or does it include investing in equity oriented mutual funds. If it means investing in stocks directly, this should be fine. If it includes equity oriented mutual funds, the next question is what should be the proportion of equity investment in the fund before the Government allows the fund to fall under Rajiv Gandhi equity scheme.
Either ways, including equity oriented mutual fund is a good idea which the Government may pursue. The only problem with this is that it kills the whole purpose of allowing equity investment under tax scheme. The purpose was to introduce equity market to retail investors not only to the secondary market but also for primary market where companies can raise capital by offering IPOs.
If implemented successfully, this scheme offers huge potential for capital market. Simple calculation shows that it will infuse about 50000 crore (assuming 1 crore people earning enough to invest 50000 under the scheme). This is a whopping USD 10 billion.
This scheme will also reduce the dependency of Indian stock market on foreign institutional investors (FII) and provide much needed stability by inducing long term capital.