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Capital Protection Schemes are nothing but psychological traps (Part 1 of 2)

No one likes to lose money. And yet everyone wants to get maximum returns on his / her investments. 

Though shares can deliver phenomenal returns, they also carry a high risk of loss. And because this aversion to loss is much more powerful than the lure of high returns, most people keep away from investing in equity. Hence, fixed deposits that offer assured and guaranteed returns, attract maximum investment.

To address this issue of 'fear of loss', financial wizards have devised an ingenious financial product... called 'capital protection product'. 

(This is available in many forms such as capital protection mutual fund, capital protection insurance policy or a capital protection debenture. But, whatever may be the form, the underlying concept, as discussed later, remains essentially the same.) 

As the name suggests, it is a financial product that protects your capital. In other words, in the worst case scenario, you will at least get your capital back. When you are assured of not losing your initial investment, naturally you won't mind investing in such a product.

But, as the blog title warns, beware! This is nothing but a psychological trap.      

First, let us see how capital protection works.

Companies (whether insurance companies, mutual funds or NBFCs) are not astrologers. Hence, they can’t protect our capital by trying to read the future.

Nor are they philanthropists, who will put in their "own" money in case the portfolio suffers a loss and pay you back at least your capital.

What they will do is actually very simple. Of the Rs.100 you invest, they will put about Rs.70-80 in debt products. The balance about Rs.20-30 will go into equity. In 3-5 years (yes, all capital protection schemes have minimum 3 to 5 year lock-in), Rs.70-80 will appreciate to about Rs.100. Therefore, even if entire Rs.20-30 invested in equity is lost, you at least get back Rs.100. Hence, your capital is protected. 

So, where's the trap?

Await Part 2 of the blog, tomorrow....

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