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Among some of the best practices followed by top investment managers, tax emerges as an important aspect to be considered. It is common to see advisors in the West talking about pre-tax returns, and more importantly, post-tax returns. However, in India, we do not talk about post-tax returns when talking about the returns of bank fixed deposits.

As investors it is important for us to ask our financial advisors, bankers or agents about the post-tax returns. The impact of tax on investment decisions cannot be underestimated.

Fixed deposit — pre-tax vs. post-tax returns

Interest earned on fixed deposit (FD) is taxed at the tax slab rate of the individual. If an individual decides to invest Rs 10,000 in an FD at 9 per cent interest rate, pre-tax interest earned during the year would be Rs. 900. Tax on the interest earned at 30 per cent tax rate would be Rs 270, and net amount earned by the investor would be Rs 630.

This translates into a net return is 6.3 per cent. which is much lower that the presumed return.

Would you decide to invest in an FD, if the net return from it was viewed 6.3 per cent instead of an overall return of 9 per cent?

Fixed income — debt mutual funds

Long-term capital gains on investments in debt mutual funds are taxed either at 10 per cent flat rate on 20 per cent indexed. Average return of short-term debt funds in the last 3 years is 8.9 per cent. If an individual decides to invest Rs 10,000 in a short-term debt mutual fund, pre-tax returns earned for one year would be Rs 890. At a flat 10 per cent tax, Rs 89 would the tax amount. Net capital gain would be Rs 801, whereas post-tax interest earned would be 8.01 per cent.

Equity — no long-term capital gains

Equity exposure is an important aspect of any portfolio that is built. In India, the government has provided an excellent incentive for long-term investors, by keeping capital gains at 0 per cent. Prudent portfolio building with long-term vision and enough risk weighted exposure to equities can go a long way in building wealth.

‘Why should I not invest is FD?’ is the most common question asked by many. As explained in the above example, a debt mutual fund could yield more than your FD investment. This is counter-intuitive and against the popular perception. However, introduction of tax has shown the reality of these decisions. Ask your advisor if tax has been considered in choosing the recommended products.

Happy investing!

ArthaYantra provides personal finance advice online.

Disclaimer: The opinions expressed in this article are the personal views of the author. NDTV Profit is not responsible for the accuracy, completeness, suitability, or validity of any information on this article.