We hate losing money. We want 'guaranteed & assured' returns. We don't like to take risk.
And since equity does not offer 'guaranteed and assured' returns (in fact, forget about returns, there are chances of losing the capital itself), that we find only a tiny minority of the investing population putting their money in shares.
Well, nothing wrong with it. If someone doesn't want to take risk, its' perfectly fine!
However, to cater to this vast population, who don't want to risk losing everything in equity — and yet want to enjoy some benefits of high returns from equity — you will come across Mutual Funds, Insurance companies and NBFCs selling the so-called 'Capital Protection Schemes'.
As the name suggests, these schemes will ‘TRY’ to protect our capital:
Note that I have used the word 'TRY' and 'not guaranteed'. To repeat again – these schemes will try and protect the capital but there is no legal guarantee.
Does that mean that these companies are telling a lie?
No. Definitely Not!
They are all intelligent and honest people. They will definitely try and protect our capital. And most likely do it too. In all probability NO ONE should lose money in such schemes.
The question is - How?
And from the answer to this question, we will get the answer to our basic question – Should we invest in Capital Protection Schemes or not?
How will Capital Protection Schemes protect our capital?
Fund managers are not astrologers. Hence, they can't protect our capital by trying to read the future.
Nor are these companies 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 that you invest, they will put about Rs.70-80 in debt products. The balance about Rs.20-30 will go into equity. In 3 to 5 years (the usual tenure of these schemes), Rs.70-80 will appreciate to about Rs.100. Therefore, even if the entire Rs.20-30 invested in equity is lost, you at least get back Rs.100.
Hence, your capital is protected.
Of course, companies may use sophisticated tools to decide on the right mix of debt and equity from time to time. But, the basic underlying principle remains the same.
So, is there is a catch?
Well, there is no ‘catch’ in the negative sense.
But yes, there is one issue – the returns.
If, like most people, you assume that you can expect HUGE equity-like returns, while at the same time your capital remains safe, then you are wrong. Remember, there’s no free lunch.
The returns from such schemes will be LIMITED.
Suppose the stock markets yield around 20% p.a. profits over the next 3 years. Then your Rs.20 invested in equity, would have become Rs.35. At the same time, Rs.80 in debt would have become Rs.100 (@8% p.a.). Thus, your Rs.100 would have appreciated to Rs.135 in 3 years, i.e. about 10.5% p.a. returns.
Thus, there is a vast difference between the expectation (20%) and the reality (10.5%).
Therefore, don’t be misled by people, who may promise you the moon from such schemes along with capital safety.
Is it worth putting your money in these schemes?
As usual, it depends!
You now know what to expect from the Capital Protection Schemes...
... Safety of your investment, but note there is ‘no guarantee’ in the legal sense
... Better returns than Bank FDs, PPF, NSC, debt funds etc. but definitely not the same as equity
... Poor liquidity as at least around 3-5 years would be the lock-in period
... Default risk, if you are buying capital-protection debentures from NBFCs
If this is what you want from your investment, then go ahead and invest.
But if you want to enjoy the returns of equity, you got to take risks. These funds will not meet your high return expectations.
IMPORTANT NOTE:
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. Hence, you can safely skip the Capital Protection Schemes.
And since equity does not offer 'guaranteed and assured' returns (in fact, forget about returns, there are chances of losing the capital itself), that we find only a tiny minority of the investing population putting their money in shares.
Well, nothing wrong with it. If someone doesn't want to take risk, its' perfectly fine!
However, to cater to this vast population, who don't want to risk losing everything in equity — and yet want to enjoy some benefits of high returns from equity — you will come across Mutual Funds, Insurance companies and NBFCs selling the so-called 'Capital Protection Schemes'.
As the name suggests, these schemes will ‘TRY’ to protect our capital:
Note that I have used the word 'TRY' and 'not guaranteed'. To repeat again – these schemes will try and protect the capital but there is no legal guarantee.
Does that mean that these companies are telling a lie?
No. Definitely Not!
They are all intelligent and honest people. They will definitely try and protect our capital. And most likely do it too. In all probability NO ONE should lose money in such schemes.
The question is - How?
And from the answer to this question, we will get the answer to our basic question – Should we invest in Capital Protection Schemes or not?
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| Capital Protection Schemes Are Nothing But Psychological Traps. |
How will Capital Protection Schemes protect our capital?
Fund managers are not astrologers. Hence, they can't protect our capital by trying to read the future.
Nor are these companies 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 that you invest, they will put about Rs.70-80 in debt products. The balance about Rs.20-30 will go into equity. In 3 to 5 years (the usual tenure of these schemes), Rs.70-80 will appreciate to about Rs.100. Therefore, even if the entire Rs.20-30 invested in equity is lost, you at least get back Rs.100.
Hence, your capital is protected.
Of course, companies may use sophisticated tools to decide on the right mix of debt and equity from time to time. But, the basic underlying principle remains the same.
So, is there is a catch?
Well, there is no ‘catch’ in the negative sense.
But yes, there is one issue – the returns.
If, like most people, you assume that you can expect HUGE equity-like returns, while at the same time your capital remains safe, then you are wrong. Remember, there’s no free lunch.
The returns from such schemes will be LIMITED.
Suppose the stock markets yield around 20% p.a. profits over the next 3 years. Then your Rs.20 invested in equity, would have become Rs.35. At the same time, Rs.80 in debt would have become Rs.100 (@8% p.a.). Thus, your Rs.100 would have appreciated to Rs.135 in 3 years, i.e. about 10.5% p.a. returns.
Thus, there is a vast difference between the expectation (20%) and the reality (10.5%).
Therefore, don’t be misled by people, who may promise you the moon from such schemes along with capital safety.
Is it worth putting your money in these schemes?
As usual, it depends!
You now know what to expect from the Capital Protection Schemes...
... Safety of your investment, but note there is ‘no guarantee’ in the legal sense
... Better returns than Bank FDs, PPF, NSC, debt funds etc. but definitely not the same as equity
... Poor liquidity as at least around 3-5 years would be the lock-in period
... Default risk, if you are buying capital-protection debentures from NBFCs
If this is what you want from your investment, then go ahead and invest.
But if you want to enjoy the returns of equity, you got to take risks. These funds will not meet your high return expectations.
IMPORTANT NOTE:
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. Hence, you can safely skip the Capital Protection Schemes.