This Diwali, invest in equity without risk

Diwali is here and the markets are on fire. Stocks are hotter than the weather outside, and you are just itching to invest your Diwali bonus into your favourite stock or equity mutual fund. True, at the back of your mind, there is this small discomfort, which is also known as risk. For the fact remains that in spite of the 20,000 milestone, there remain many unsettling issues. The sub-prime situation has not yet fully played out as every now and then a global financial institution comes out declaring write offs in the region of billions of dollars. The price of crude oil is nearing $100 provoking a person of the stature of no less than Mr Greenspan himself to declare that he fears an American recession around the corner. Domestically, the Participatory Notes (PN) policy is too recent - the long-term or even the medium-term effects have yet not manifested. Political uncertainty too looms large. Lastly, the neighbour has an emergency.

However, there is a way that you could invest your bonus into equity and yet not undertake risk of losing your capital.

Numbers being easier to understand, lets assume similar numbers as were used in the previous article. (Also read - Learn to invest in equities without an iota of risk) Note that the figures used are not important, the concept is. If your investment amounts are different, invest proportionately.

Lets assume that you have received a Diwali bonus of Rs. Five Lakh. You want to invest it well, preferably in equity, but with minimal or no capital risk. I 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. 4,12,000 in any three-year bank fixed deposit (FD). Nowadays, FDs are offering 9.5% p.a. or 6.65% p.a. after tax (assuming a 30% tax rate). Therefore, over three years, Rs. 4,12,000 would grow to Rs. 5 lakh at the post tax interest rate of 6.65% p.a. So no matter what happens, three years later, you will receive Rs. 5 lakh. However, now you have a lump sum of Rs. 88,000 left over. (Rs. 5 lakh – Rs. 4.12 lakh). Invest this Rs. 88,000 in an equity mutual fund. Now, realize that no matter what happens to the money invested in the mutual fund, at the end of three years, the capital invested in the FD is going to net you Rs. 5,00,000 which is what you originally started out with. The market value of the Rs. 88,000 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 November 2004. The balance amount was invested in Reliance Growth Fund on a lump sum basis. Now, Rs. 88,000 invested in Reliance Growth in November 2004 would have grown to Rs. 3,90,000 (rounded off)  in three years time. Tax-free. Add to it the FD of Rs. 5 lakh and the total investment would net a cool Rs. 8.90 lakh. Not only have you protected your capital but benefited from the long-term benefit of equity.

Now, its not as if I am implying that such returns would be repeated in the future. It is possible and at the same time it is not. However, readers will appreciate that there is no way of trying to judge the future except by the past. All I am 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.

The recent capital guarantee schemes that are launched shortly use a similar mechanism. However, note that none of the fund houses actually guarantee that the capital is protected. Instead a credit rating agency assigns a rating to such schemes that signifies a high degree of certainty regarding timely repayment of the face value of the investment.

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.

No wonder they say, a steady job and a mutual fund is still the best defense against social security.

- Sandeep Shanbhag

The writer is Director, A N Shanbhag NR Group, an investment & tax advisory firm. He may be contacted at sandeep.shanbhag@moneycontrol.com

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