'Sensex to touch 100,000 by 2020' screams a newspaper headline. The dream run on the stock indices in the last two to three months has fuelled renewed interest in equity investing.
But investors who keep most of their money in 'safe' bank fixed deposits despite the low returns (due to the high tax on it) are like avid weight watchers who eat health food and also wish to be more like their neighbour who enjoys sinful foods such as ice-cream and still manages to remain slim and fit.
This piece is not about whether the equity markets will actually provide the high returns in the period being spoken about but whether these 'health food' investors have an option which will give better returns than bank fixed deposits but with a lower risk of seeing an erosion of their principal investment.
There are several such options. The most obvious one is investment in mutual fund schemes that invest exclusively in long-term government securities (called gilt funds). Most people know the value of government securities (and, hence, the net asset value or NAV of the mutual fund that invest in) rises when interest rates fall and declines when interest rate increase. Additionally government securities price (and hence mutual fund NAVs) rise every day as interest accrues every day. In normal circumstances unless the interest rate rise is dramatic and happens very early after your buy, any drop in price from this factor is more than offset by the relentless increase in NAV that occurs every day due to interest accrual. Thus, if you invest in gilt funds and hold the investment for at least a year then at least your principal is guaranteed.
If you hold the investment for a couple of years then the relentless increase in NAV due to interest accrual will more than make up for any drop in NAV due to an increase in interest rates. So, if your holding period is more than a couple of years, the worst outcome that you can expect is a low return. This low return will be tax-free (because your investment will be indexed) and will still compare favourably with the post-tax return on a bank fixed deposit. There is no credit risk in a gilt fund since it invests only in government securities. The worst case scenario if you are willing to invest your money for a couple of years in a gilt fund is that your post-tax return will be around the same as the post-tax return on a fixed deposit.
It is the best-case scenario that should clinch the arguments in favour of this investment by 'risk-averse' investors of a bank fixed deposit. Interest rate always moves in a cycle and we have been in a high interest rate cycle for a few years now. It debateable whether we are at the peak of the cycle or not, but at some point of time, in the not so distant future, the cycle is bound to turn as it always has in the past. When that happens and the interest rate drops the NAVs of gilt funds will rise significantly and the returns can be much higher than a bank fixed deposit. But because of low or no taxation (due to indexing referred to earlier) the post-tax return will be significantly higher than return on a bank fixed deposit.
Clearly, the risk to reward ratio pays off very well. In addition, if an investor needs money earlier than the investment period of two to three years, the gilt fund is likely to have lower cost than bank fixed deposits.
In short, if the 'safety' seeking investor will move only a little bit out his comfort zone he can hope to make much better return on his investment without taking any significant additional risk. I welcome comments from 'safe' investors.
The writer is CEO, Apnapaisa
