What is the best way to lose your capital?

Vijai Mantri

To know the best way to lose your capital, you need to begin by understanding the meaning of capital. Capital refers to our hard-earned money, which is being saved by us over the years.

Why then do we save in first place? We save to meet a specific need or goal in the future, or perhaps for contingency. Thus, what we do is that we choose to invest the money we have with us instead of spending it, and wait for consumption at a later date.

The money that you earned could have been spent on buying things you thought you needed today. Nonetheless, you chose to invest, by reasoning that you would rather use this purchasing power some other time in the future. In this manner, the money that you saved has become your capital.

Suppose you wish to exercise the option of taking out your capital and spending your money. Now, this capital that you invested should have earned you enough to buy things you intended to buy in the first place.

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Vijai Mantri

Chief Mentor and Co-Founder |Buckfast investment Advisory Services

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It essentially is trying to protect not your currency notes or bank balance, but the ability of money to buy something for you. Basically, you are trying to protect the purchasing power of your money in the name of capital protection.

What is the biggest risk to capital? It is the rise in prices, also referred to as inflation or mehengai. When we say protection of capital, we mean that our future capital should be able to grow higher than our expenses. This is capital protection.

The rate of growth of the saved money (capital) should grow at a rate that is higher than the increase in expenses. If the rate of growth (investment returns) of the saved money (capital) is less than the increase in household expenses, then we are simply destroying the capital.

Therefore, the question that arises is: which investment option surely and certainly destroys our capital? Well, the first choice of Indian investors is a financial asset called fixed deposits (FDs).

Let us understand this through a simple illustration. Suppose you have Rs 1 lakh and you want to spend this money on buying a TV or a refrigerator or on a holiday package. Instead of splurging on these items, you invest the money in fixed deposits for a period of three years.

After three years, your capital has grown from Rs 1 lakh to say Rs 1.21 lakh (annual growth of 7 percent). But during the same time period, prices of these three products/services went up by 10 percent per year and these now cost Rs 1.30 lakh.

In short, FDs have destroyed your capital. This illustration is from a short-term perspective. You can still fill this gap through other sources.

Now, imagine the impact of the same thing over your life span. Again, let us assume that you are a 30-year-old individual earning Rs 1 lakh per month, with the ability to save up to Rs 30,000 per month, which you again invest in FDs or similar investment options.

You work for the next 30 years. During this period, your income grows by say 8 percent per annum and your expenses grow by 7 percent per annum. You have kids and you educate them, and also marry them. You retire at the age of 60 and all your savings have been in options like FDs.

When you retire, all you have is your ‘Safe’ FDs. You have created some corpus and you will run out of capital by the age of 70. What will you do when you run out of capital at the age of 70? See the havoc played by supposedly safer and much-loved FD in your golden years of retirements!

If you see a big banyan tree and look at the shadow of that big tree, you will find that absolutely no vegetation thrives on that patch of land. Why? Because, the big banyan tree does not allow steady sunlight to reach the surface below. Sunlight can be harsh and energy-sapping. But in essence it is the elixir of life. This is what FDs do to your capital. There is no growth, no life. Therefore, do not stay in the shadow of the banyan tree, i.e. fixed deposits.

(The writer is Chief Mentor and Co-Founder of Buckfast investment Advisory Services.)