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

In Part 1, we looked at what Capital Protection Schemes are and how exactly do they work. We now continue with Part 2.

So, why are such capital protection schemes a psychological trap?

They are so because they play upon your psychological aversion to losing money. They reassure you that you will not lose money. But they do not tell the "truth" about the returns that you could actually make in such schemes.

People are misled into believing that they can make "huge equity-like" returns (without the risk of losing money if the market crashes). This, however, is not true.

Rather, as 70-80% money is invested in debt products, the returns from such schemes will be limited. Hence, expecting high returns is nothing but an "illusion". 

Assuming that equity gives 30% returns p.a. (this, of course, is a matter of separate discussion, but 30% is quite ambitious), then your Rs.20 will become Rs.44 in 3 years. And Rs.80 in debt would have become Rs.100 (@8% p.a.). Thus, your investment of Rs.100 will beocme Rs.144 in three years, i.e. only around 13% returns p.a. even as equity markets have appreciated by 30%.

So that's Issue No.1 - You can expect somewhat better returns than debt funds, bank FDs, NSC, PPF etc. but definitely not the stupendous equity-like returns
Issue No.2 - No liquidity as there will be at least 3 to 5 years of lock-in (and much more for insurance plans)
Issue No.3 - Unnecessarily paying higher costs in the guise of capital protection
Issue No.4 - Capital protections debentures from NBFCs have a high 'Default' risk

Concluding, such schemes are avoidable. You can achieve the same objective by investing a part of your corpus in debt MFs and the balance in equity MFs. Benefits of doing it yourself — lower charges, lower risk, greater flexibility, higher liquidity and better tax-efficiency.

(Note: There is no 'legal guarantee' that your capital would be protected. But yes, in all probability no one should ideally lose money in such schemes from mutual funds and insurance companies. But, as mentioned earlier, with NBFCs there can be a risk of default.)

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