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Protect your money with diverse investments

By Sandeep Shanbhag
December 08, 2010 15:43 IST
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Even though stock market valuations are high and pose some degree of increased risk, one cannot deny the fact that equity markets are an avenue to earn an attractive return.

Can you really invest in the stock market without undertaking any risk? Perhaps, if you structure your investment in a certain way.

First, lets look at the background or the profile of the investor who can consider the avenue. It would be the typical 45-plus investor.

If you are one such investor, you are likely to earn a healthy return, but your situation in terms of family responsibilities, loan repayments, possible medical and other future expenses may not always allow you to undertake much risk.

So fixed income investing may not leave much in hand after tax. But the risk and volatility associated with potentially higher earning equities may not be thrilling either.

We shall consider for this discussion an investible amount of Rs 5 lakh. The exact amount doesn't matter: it might as well have been Rs 5,000 or Rs 50 lakh - the principle will not change.

The figures used are not important; the concept is. If your investment amount is different, invest proportionately.

So, assume you have Rs 5 lakh. You want to invest it well, preferably in equity, but with minimal or no capital risk. Let's devise a strategy of investing a lumpsum in equity with no risk.

The blueprint

Here's what you do. Out of Rs 5 lakh, invest around Rs 3.87 lakh in any five-year bank fixed deposit (FD). Nowadays, FDs are generally offering 7.5 per cent yearly or 5.25 per cent yearly after tax (assuming a 30 per cent rate).

Therefore, over five years, Rs 3.87 lakh would grow to Rs 5 lakh at the post-tax interest rate of 5.25 per cent per year. So, no matter what happens, five years later, you will receive Rs 5 lakh.

However, now you have a lumpsum of Rs 1.13 lakh left over (Rs 5 lakh minus Rs 3.87 lakh). Invest this Rs 1.13 lakh in an equity mutual fund.

Now, realise that no matter what happens to the money invested in the MF, at the end of five years, the capital invested in the FD is going to get you Rs 5 lakh, which is what you originally started with. The market value of the Rs 1.13 lakh invested in equity is just additional icing on the cake.

To see how this strategy can actually work out, here are some numbers. Say you had purchased the FD on December 1, 2005.

The balance amount was invested in HDFC Top 200 Fund on a lumpsum basis. Now, Rs 1.13 lakh invested in HDFC Top 200 in December 2005, would have grown to around Rs 3.40 lakh in five years (tax-free).

Add to it the FD of Rs 5 lakh and the total investment would have grown to a cool Rs 8.40 lakh. Not only have you protected your capital but benefited from the long-term benefit of equity.

The only caveat: the returns mentioned above are the fund's returns in the past. This may or may not be repeated in the future. However, there is no other way of judging the future except based on the past.

The point remains that such a structure ensures that no matter what happens to the equity investment, the base capital you had begun with stays intact.

The capital protection funds being launched nowadays use a similar mechanism. However, note that, none of the fund houses actually guarantee that the capital is protected.

They aren't allowed to do so by the Securities and Exchange Board of India. The offer document may at best contain a mention that the schemes are oriented towards capital protection with a high degree of certainty but they don't actually guarantee it.

Note that the structure explained in the article, if adopted by the investor, essentially guarantees his capital.

There are no 'degrees' of certainty involved, just plain, old, pure certainty. One belief that has stood the test of time - a steady job and a mutual fund is still the best defense against spiralling inflation.

The writer is Director, Wonderland Consultants.

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Sandeep Shanbhag
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