Over a year back, we had written about investing in equity without taking any risk whatsoever. Now once again we revisit this topic as the markets are getting overheated. Analysts, prone as they are towards a herd mentality, have all started singing the same tune – that a steep correction is round the corner. Never mind the fact that these so called analysts have almost always been caught wrong footed.
But today’s piece is not about stock market gurus and other story tellers. It’s about the age old dilemma that an investor faces – while the markets are high and pose a certain degree of increased risk, fixed income avenues offer no succour.
Fixed deposit rates at around 7 per cent – 7.5 per cent per annum, do not even cover the actual inflation rate (here we do not mean the published inflation data but the real inflation that the man on the street is facing). So what is an investor supposed to do? How can one ensure safety of one’s money and yet earn an attractive return? How do you have your cake and eat it too? Or in the context of today’s article, can you invest in the stock market without undertaking any risk whatsoever? Perhaps you can, if you structure your investment in a specific manner.
But first a little background on the profile of the investor we are considering. You are the typical 45+ investor. While you would like a healthy return on your investments, your life situation in terms of family responsibilities, EMI payments, possible medical expenses in the future etc. don’t allow you to undertake much risk. So while on the one hand, fixed income investing doesn’t leave much in hand after tax, at the same time, you are not too thrilled with the risk and volatility associated with potentially higher earning equities. So what do you do? How do you come out of this Catch-22 situation?
We shall consider for the purposes of this discussion an investible amount of Rs 5 lakh. Here we would like to impress upon readers that the exact amount doesn’t matter, it might as well have been Rs 5,000 or Rs 50 lakh — the principle will not change. In other words, the figures used are not important, the concept is. If your investment amount is different, invest proportionately.
So, let’s assume that you have Rs 5 lakh. You want to invest it well, preferably in equity, but with minimal or no capital risk. We like the sound of the words “with no capital risk” more than “with minimal risk”. So let’s devise a strategy of investing a lump sum in equity with no risk.
Here’s what you do. Out of Rs 5,00,000, invest around Rs 3,50,000 in any five-year bank fixed deposit (FD). Nowadays, FDs are offering around 7.25 per cent per annum for a five year deposit – give or take. We have left out the tax angle here for ease of understanding. Therefore, over five years, Rs 3,50,000 (Rs 3,52,357 to be precise, but we have rounded off for convenience) would grow to Rs 5 lakh at the interest rate of 7.25 per cent per annum. So no matter what happens, five years later, you will receive Rs 5 lakh. Now you have a lump sum of Rs 1,50,000 left over (Rs 5 lakh – Rs 3.50 lakh). Invest this Rs 1.50 lakh in an equity-based mutual fund. Now, realise that no matter what happens to the money invested in the mutual fund, at the end of five years, the capital invested in the FD is going to net you Rs 5,00,000 with which you originally started. The market value of the Rs 1.50 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 purchased the FD in August 2013. The balance amount was invested in Birla Sun Life Equity Advantage Fund on a lump sum basis. Based on the NAV of this fund five years back and the NAV now, the Rs 1,50,000 invested in August 2013 would have grown to around Rs 4,70,000!! Add to it the FD of Rs 5 lakh and the total investment would net a cool Rs 9.70 lakh – without an iota of risk. Not only have you protected your capital but benefited from the long-term benefit of equity.
One caveat. For a moment do not assume that we are implying that such returns would be repeated in the future. It is possible and at the same time it is not. However, you will appreciate that there is no way of trying to judge the future except by the past performance. All we are saying is that such a structure ensures that no matter what happens to the equity investment, the base capital that you had begun with stays intact.
Also, the choice of the mutual fund scheme is random – all we done is chosen a mutual fund scheme that has stood the test of time; there are several more such funds that will qualify based on this parameter.
By the way, do note that the capital protection funds that get launched nowadays use a similar mechanism. However, note that none of the fund houses actually guarantee (they aren’t allowed to do so by Sebi) that the capital is protected. 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 himself, essentially guarantees his capital. There are no ‘degrees’ of certainty involved, just plain old pure certainty. We have said it in the past and will do so again — a steady job and a mutual fund is still the best defence against spiralling inflation.
The authors may be contacted at firstname.lastname@example.org