Tuesday, 21 February 2012

Simple Investment Plan-2012

grant cochrane
Over the weekend I happen to meet one of my childhood friends Ashwin. Ashwin is well settled doctor, pretty jovial in nature.  When it comes to personal finance, all that Ashwin understands is "Capital Protection is the key when you choose investment product". In other words, he believes one should avoid products that involve market risk.  His investment amount should be intact.

Let me give more insight for Ashwin’s nature. Ashwin’s Dad a retired bank employee thinks that Bank is the safest place to park your money. Stocks or Mutual Funds are not the right product for investment. Ashwin wants to invest money only in FD’s because his Dad did the same. He wants to invest in Safe products because he has been told by his dad that, it makes no sense to risk your money for mare extra 4 to 5%. Last year based on one of his relative’s recommendation Ashwin invested in couple of mutual funds that promised Capital Protection and Highest NAV. Today when he evaluates these funds, he is not very happy as the returns are not as showcased by the relative. Over all he thinks it was bad decision to invest in those funds.
In short Ashwin and his Dad think it makes sense to invest in bank instead of risking the money by investing in stocks or mutual funds that could give 4 to 5% more than Bank FD’s. 
Scenario: Ashwin has 5 Lakh at his disposal. He wants to invest this money for long term, probably 20 to 25 years. He is open for options as long as somebody guarantees that there is not negative impact on his 5 Lakh investment.

Here are some of the options we came up with:
Option 1: Invest entire 5 Lakh in BANK in Ashwin’s Name.
Ashwin’s Response:  J He was happy as this is what he and his dad wanted.

Option 2: Invest 5 Lakh in Ashwin’s dad’s Name.
Ashwin’s Response:  J JHe was very happy as he never knew that his dad could help him in getting better interest rate and also help him in reducing the tax burden. (His dad is senior citizen).
Option 3: Invest entire 5 Lakhs in Mutual Funds.
Ashwin’s Response: He asked me, if I knew the value of money.  What if the stock market crashes? Can you guarantee that I don’t loose on my 5 Lakh investment? I ran out of my ways to convince Ashwin and finally gave up. Based on Past performance it Equity Diversified MF have the potential to give 15% returns if invested for long term. This option was ruled out by Ashwin as; it does not guarantee capital protection.
Option 4: Win Win Situation or 80:20 Rule. Invest 20% in FD and 80% in Equity Diversified Fund.
Ashwin’s Response: He was kind of confused but was eager to know more about it, provided his preliminary condition of capital protection is met. Here is our plan. Out of the 5 Lakh, Invest One Lakh in Fixed Deposit. Remaining 4 Lakh to be invested in equity diversified funds. One Lakh would be invested as per Option 2, which is Ashwin’s dad would be the primary applicant and Ashwin the secondary applicant.

Let us chart the returns for 5 Lakhs for above discussed options – assuming 25 years is the period.

Investment Details
Maturity value
5 Lakh in BANK FD in Ashwin's name @ 10%
59 Lakh
5 Lakh in BANK FD in Ashwin's Dad name @ 11%
75 Lakh
5 Lakh in MF - assumption 15% CAGR
1.64 Crore
1 Lakh in BANK FD in Dad's name and 4 Lakh in MF
1.45 Crore
#Calculation Assumptions: Quarterly compounding in case of bank FD. Annual Compounding in case of MF.Maturity value are Approximate.
The maturity value clearly depicts that Investment in MF is the clear winner. It beats bank maturity value by a big margin.

Let us dig in more on option 4 or the 80:20 Rule:  Ashwin’s primary condition was capital protection. By investing 1 Lakh in Ashwin’s dad’s name and 4 Lakh in MF the maturity amount stands to 1.45 crore.  1 Lakh invested in BANK FD matured to approximately 15 Lakh and 4 Lakh invested in MF would mature to 1.3 Crore.  So the total returns by investing as per Option 4 was 1.45 Crore.
Take away: A simple strategy helped not only protecting the principle but getting earning handsome returns.
Note: All the characters in this article are made-up. The idea is to just show how one can earn better returns without losing on capital investment. 
What would be your strategy for people like Ashwin?


Madbull-Ram said...

As always, exellent write-up. One more option would be to invest in eGold. Bcos many Ashwin's will not say yes 80:20 rule, they would rather prefer 50:50 or 20:80 rule bcos of their fear.

So may be a worst Ashwin can look at 50 in MF: 40 in eGold : 10 in FD what say?

WealthUCreate said...

Thanks Ram :). Regarding the ratio for diversification, it depends on your risk appetite. The primary goal was to protect capital invested. Remaining portion could be diversifed into various investment product that has the potential to give decent returns.

Anonymous said...

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