In recent few days there have been a deluge of Capital Protection Funds from Mutual Fund houses. I have often been asked should I invest in these Capital Protection Funds?
What is Capital Protection Fund?
We hate to loose our hard earned money. Taking advantage of this emotion, Mutual Funds launch Capital Protection Fund when the stock market is volatile. These funds promises investors to give a minimum guaranteed return which is the capital invested or may be a nominal appreciation of 10% on the same at the end of investment tenure.
But do you know you its easy to create your own Capital Protection Fund!
This can be done in two ways.
- Invest the entire amount in Debt Instruments like Fixed Deposits etc and invest the interest so earned in equities.
- Invest partly in fixed deposit and partly in equities.
Both the concepts are explained below with examples.
First the Assumptions:
- Amount to be invested: Rs 5 lakhs
- Investment Tenure: 5 Years
- My aim is capital protection so the minimum I expect is Rs 5 Lakh after 5 years. Anything above this is bonus 🙂
- Invest entire 5 Lakh in a Monthly Income Plan or Fixed Deposit paying out monthly interest.
- For example I invest entire 5 lakh in 5 years Post Office Monthly Income Account Scheme. This gives annual interest of 8.2%. So monthly I would get Rs. 3,416.67.
- I invest this interest payout in any good diversified equity scheme as Systematic Investment Plan (SIP).
- At the end of 5 years I have 5 lakhs still in my Post office account. All the investment I made in the equity fund is my additional income.
- So in worst case I would be able to preserve my capital i.e. Rs. 5 Lakh as promised by most Capital Guarantee Funds.
- While on an average case scenario, taking 12% annualized returns on equities I would make 2.77 Lakhs. So I would have around 7.77 Lakhs at the end of 5 years tenure.
- This means an annualized compounded return of 9.2%
- Open a fixed deposit account with SBI offering 9.25% interest and invest Rs. 3.2 Lakhs. At the end of 5 years this FD would give me Rs. 5 Lakh. So investing Rs. 3.2 Lakh has preserved my capital.
- The rest of Rs. 1.8 Lakh can be invested in diversified equity mutual fund.
- At the end of 5 years, in the worst case scenario if I lose all my money in equity investment I would be left with 5 lakh.
- While in the average case scenario taking 12% annualized returns on equities I would make Rs 3.1 Lakhs. So a total of Rs. 8.1 lakh
- This means an annualized compounded return of 10.2%
In case you are in Hurry or prefer short reading below is the picture:
Both the above solutions are good and both the methods work equally well for capital protection. Now go ahead and create your own Capital Protection Fund!