ZERO RISK EQUITY INVESTING-II
The rains don’t seem to have had any dousing effect on the stock market fire. Though at 30,857 points it has pared down a little from an all time high of over 31,000 points reached 2014, the fact of the matter is that investors, both domestic and foreign, can’t seem to have enough of our markets.
And not surprisingly so. India is one of the fastest growing economies in the world.
A near absence of the toxic assets that the West is reeling under, limited dependency on exports and foreign capital, robust corporate earnings growth on the back of domestic demand, a savings rate of 35%, very comfortable forex reserves and a favourable demographic makes India one of the most attractive investment destinations in the world.
That being said there are some dark clouds. Valuations aren’t cheap. At over 22X earnings, the Indian market is already one of the most expensive markets in the world. Also, domestically with the demonetisation that took place in November and the imminent GST implementation, there is a fair bit of uncertainty. 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 there from 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 assume similar numbers as were used in the previous article. 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% 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.
To see how this strategy can actually work out, we ran some numbers to see how this strategy would have worked out had it been implemented five years ago. Say you received your first interest in June 2012 (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.2.54 lakh just on account of the mutual fund investment!!
The effective rate of return works out at an astounding 18.03% 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. 7.54 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. 7.54 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.
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- only take care to invest in a bank FD with monhly interest. So who’s afraid of equity now?