At the time of writing this, the BSE Sensex is 38,275 points. At almost 28X earnings, the market is not cheap. Also there is a fair bit of uncertainty built in. The US political situation continues to be a major red flag. The geo-political risk looms large and if the West were to fall back into recession, the liquidity
supply which is so essential to maintain this rally may suddenly dry up.
So under the circumstances, what does the retail investor do? On the one hand, the temptation to ride this boom is tremendous. On the other, the risk is greater than ever before. Is there a way that you can benefit from this market surge and at the same time limit the attendant risk?
Last week we had seen one of the ways to do that. The idea was simple yet effective. Invest a major part of your capital into a bank fixed deposit such that over five years the money grows back to the original amount you started out with. Thus having the security that your base capital will remain intact, the balance can be invested into a diversified equity mutual fund scheme with a five year time frame. This way you take no risk on your principal amount, yet you can benefit from the equity upside, if any.
There is yet another way to achieve this goal. The idea is equally simple and equally effective. Invest your entire capital in a fixed income instrument and invest the returns therefrom in equity. This way too, your capital remains intact, yet you can benefit from the potential of equity upside.
Numbers being easier to understand, let us understand how this works with the help of a numerical example. Note that the figures used are not important, the concept is. If your investment amounts are different, invest proportionately.
It is assumed that the investible capital is Rs 5 lakh. Invest this Rs 5 lakh in any bank deposit. At an interest rate of say 6.5 per cent p.a., you will receive Rs 32,500 per year or Rs 8,000 (rounding off) per quarter.
Now, enter into a quarterly SIP in a good equity oriented fund with this amount of Rs 8,000. The bank deposit is for a term of five years — so basically, you would invest Rs 8,000 per quarter for five years. At the end of five years, you would receive the market value of your mutual fund investment and also the capital amount of Rs 5 lakh invested in the bank FD.
Consequently, while you have kept your capital intact, you still have taken on equity exposure with all its associated risk. To put it differently, no matter what happens to the market — even if it shuts down, your Rs 5 lakh is safe with you.
We ran some numbers to see how this strategy would have worked out had it actually been implemented five years ago. Say you received your first interest in September 2013 (five years back). The quarterly interest was invested in Birla Sunlife Frontline Equity Fund on a quarterly SIP basis. By adopting this simple structure, at the end of five years, the investor would have received around Rs 2.32 lakh just on account of the mutual fund investment!! The effective rate of return works out at an astounding 14.32 per cent p.a. Add to it the capital amount of Rs 5 lakh of the Bank FD and the total investment would net a whopping Rs 7.32 lakh, done and dusted — without an iota of risk!!
Some points to chew on Now before you start looking for your cheque book, consider the following.
First and foremost, the above analysis, of course gives us only an idea about what would have happened had this strategy been implemented through the past five years. But who knows the future? Perhaps you would earn less or perhaps you would earn so much that the Rs 7.32 lakh may seem a pittance. But whatever happens, be rest assured that your base capital of Rs. 5 lakh would remain protected.
Which brings us to the second aspect of this exercise. It is only your base capital of Rs 5 lakh in our example, which remains protected. But it does not cover inflation. Obviously the value of Rs 5 lakh five years later would not be the same as it is today. But hey, with no downside and only upside, it’s a deal worth considering, isn’t it?
Some readers may point out the analysis will change as per the interest rate assumed. True — one can do the same exercise incorporating the relevant interest rate for each year. But that would just compromise simplicity for accuracy. The point of this article is not the precision of the numbers i.e., not how much exactly your capital would grow to — but the fact that adopting this strategy allows you to enjoy pure unadulterated equity pleasure with the guarantee of not losing your base capital.
Similarly, the scheme selected (Birla Sunlife Frontline Equity) is one of the many well performing equity diversified schemes available. The specific scheme doesn’t matter, you will find similar results from other well to do diversified mutual fund schemes.
Last but not the least, here we have assumed a quarterly SIP for simplicity and ease of understanding. Some MFs may not offer quarterly SIP. However, an investor can very well adopt the same strategy with a monthly SIP — only take care to invest in a bank FD with monthly interest.
So who’s afraid of equity now?
The authors may be contacted at firstname.lastname@example.org