The usual way Investors protect the capital:
Normally, in two different situations, the investors look into protecting the capital by preserving it.
1. When the asset prices are too volatile
2. When risk is alleged to be high with any particular product
In these scenarios, the investors hide inside their shell to safeguard their hard earned money rather lose it by trying to invest in high risk instruments. After looking at the capital that doesn't grow due to fear of losing it, the investors seek advice from the experts for options.
Are bank FDs the safest and the best mode of protecting your capital?
The answer is ‘yes' and ‘no'. When you invest in bank FDs, your money is safe. But, the investors get confused when they struggle to beat inflation with the return they get from bank FDs. Normally, bank FDs offer you an interest of about 8.75%-9.25%. After you pay taxes on the interest earned, you earn returns approximately at 7%. Did you know for the last five years, the inflation rate is at 7.5%? It makes your investment value as same as what you invested initially. You gain nothing extra here.
Understand how these safest capital protection mutual fund schemes work?
You wanting an upside with bank FDs and seeking risk free protection is a clear paradox, you can't have a cake and eat it too.
You need to understand things clearly. Say For example, you are investing 30 lakhs in a fixed deposit. You are amazed at the statistics comparing capital protection mutual fund schemes over bank FDs given by the banker who sells these, right?
From your capital protection mutual fund scheme investments, the bank earns a huge sum of approximately 1 lakh as a fee and the banker earns an incentive. This is the reason banks broadcast and advertise extraordinary about their high risk averse HNIs over other capital protection plans. Remember, you gain no hot revenues which does any good to your portfolio.
So, what is the best alternative capital protection plan if not bank FDs?
Well, you have liquid funds to choose from mutual funds. The bankers will not advocate such plans as they incur low fees for them. These fixed mutual liquid funds are the best alternative to your ‘so called safe' plans in name of bank FDs. There are debt funds that offer low risk products such as capital protection funds and FMPs (Fixed maturity plans).
How does the capital protection funds work?
Understanding how capital protection mutual fund schemes works is not a rocket science. Let me explain it simply. When you choose capital protection mutual fund scheme, 80% of your investment goes into fixed income securities and the remaining 20% is invested in equity funds. This arrangement makes sure your capital is safe as the 80% invested in FDs are kept until the tenure of the scheme. You gain an excess return on your capital through the 20% invested in equity products. A point to remember here is the risk associated with this small portion when the market is volatile. If you are ready to take a little risk with 20% of investing your capital in equities during a volatile market, then go for this scheme.
How does the FMPs work?
The fixed maturity plans gain returns as they are invested in bonds and held until maturity. Your capital is invested in couple of certificates which trade at 9.5% or more. These investments are held until the period of maturity. After deducting the incurred expenses, the investors get a return at the rate of approximately 9%. This is slightly higher than other short term funds or liquid funds.
Ok, how do these investment products differ from bank FDs?
Safer Investment Option: Well, I can't say this as a difference, but these mutual fund models offer the same level of protection as the bank FDs since these are invested for a fixed period. But, the key difference is the multiple options you get here.
- If you want to invest your capital for a shorter period, FMPs offer options to invest for minimum 30days onwards and available even for 3 years.
Works best at all times: If you want to protect your capital when the bond yields are high, safely invest in FMPs.
Save on Tax with long term capital gains: You pay taxes of about 20% with indexation and 10% without indexation from long term capital debt funds gain. This helps in adjusting the buying price in accordance with inflation and you get an edge from your taxes on interest over normal FDs.
Alternatives to Capital Protection Funds:
Capital protection funds invest 80% in debt and 20% in equity. You can do this on your own. That is you can invest 80% of your money in FD or FMP or debt fund and invest the balance 20% in equity funds.
Mostly, the capital protection funds have high expense ratio.
So instead of investing in capital protection funds, you can create your own capital protection asset allocation combination.
K. Ramalingam is the chief financial planner at holisticinvestment.in, a leading financial planning and wealth management company