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In today's market, investors look for safety of their capital. And the market is flooded with capital protection schemes. Essentially, these are structured in such a manner that they assure investors that their capital is safe. An investor's capital is returned at the close of the investing period.
Consumer interest is sparked by a "capital-protected" investment for two reasons. First, it creates a mirage for naïve investors where they see a safe bank deposit which would also give them stellar returns (as the Indian equity market bull run did in the period leading up to early 2008). Second, it creates a myth in their minds about complicated instruments conjured up by financial wizards with complex algorithms, and a false belief that these guys "certainly know their stuff" and will make it work, no matter what happens in the markets.
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Protecting your capital is, in reality, quite simple. Though financial planners could get carried away and ask you to stash money under your pillow, that would result in inflation eroding the value of your money in addition to, of course, making for a very uncomfortable resting place for your head. Bank deposits or similar debt instruments are reasonably safe assets for retail investors.
The flip side is that protecting capital also comes with the baggage of lower returns. Taxes on interest income from most debt instruments being what they are curtail returns even further. A large fund house parks a significant amount in debt securities when it offers you a capital-protection oriented scheme.
A simple structure
However, if you have the time and the inclination to create a capital-protected structure for yourself, here's how to do so - and without having to purchase a complex product designed by a financial wizard.
Say, you have Rs 1 lakh which you want to invest for five years. This is what you do. Split the money between two instruments. Invest nearly 65 per cent in a cumulative fixed deposit of a public sector bank at 9 per cent for five years. The balance can be invested in equity funds, stocks or gold or any other asset that could potentially provide you with higher returns.
After five years, Rs 65,000 invested in the growth option of a debt mutual fund would grow to Rs 1 lakh, equal to the capital you had initially invested. Even in the unlikely event that the rest of the money you had invested in riskier assets such as stocks or equity funds were to fall to zero, you would still be left with Rs 1 lakh at the end of five years.
Of course, how much the debt part of your investment grows to is a function of the rate of interest offered by a bank and the tax rate applicable for you. But bank employees could help make the requisite amount of investment for you to reach your target.
The important thing to note is that you are now free to take significant risks with the rest of your capital since you have protected the base amount.
The question that may arise in your mind is, "Doesn't the time horizon also determine the amount you can keep as an FD (fixed deposit)?" The answer is yes, of course.
In fact, a longer investment horizon allows you to park a larger sum in equity funds (or other high-risk, high-return instruments). The need to put money in safe debt instruments such as FDs or debt funds (to protect your capital) decreases steadily.
While banks may not offer FDs for more than 10 years, there are safe debt instruments such as the Public Provident Fund, which provides stellar returns over a 15-year period in addition to keeping your capital very, very safe. What renders this kind of investing even more attractive is that the returns on PPF are tax-free.
Structures for the long haul
Now the question arises regarding how this method can be applied to your investing plan. Let us take up the special case of investing for your child's education.
Say, your daughter is two years old and you are saving for her college expenses. You wish to set aside Rs 1 lakh every year over the 15 years you have left to save. Further, you just want to make sure this amount is invested right and the capital investment of Rs 1 lakh every year is protected.
You could look at a combination of PPF and mutual funds in order to structure a capital-protected fund for your daughter's education. For instance, in year 1 you would put Rs 29,414 and Rs 70,856 into equity funds. As you get closer to your goal, you would progressively invest more in PPF and less in the funds. Your annual investment amount of Rs 1 lakh stays the same. In year 15 you would invest only Rs 7,834 in the equity fund and Rs 92,166 in the PPF.
By the time you are done, you would have invested only 55 per cent of your money in PPF and the balance in equity funds (or other such high-return instruments) that are expected to yield superior returns. Even if these do not yield the values you expect, you will still have protected your capital. Chances are you will be left with a considerably larger corpus at the end of the 15 years.
Depending on how your equity fund performs, let us look at the following scenarios: The worst case scenario: if you lost in equity, you would still be left with Rs 15 lakh. But equity funds over 15 years, should make at least Rs 25 lakh. So, there is everything to gain, and nothing to lose.
The writer is co-founder and COO,BigDecisions.IN
