High risks of playing too safe

Jun 04 2012, 10:39 IST
Comments 0
SummaryEquity must be explored as the opportunity loss of conservative investments is quite high

We dicuss-ed opportunity loss last week and here is the second part of it. We continue the story of you having about Rs 10 lakh to invest. How do you then mitigate opportunity loss by minimising volatility factor? There are many theories here and we shall discuss a few.

Option 2: Just an FD investment.

Assume that fixed deposit gives you about 9 per cent returns which would translate into earnings of R 90,000 for the year. Deduct tax liability @30 per cent and you get about R 90,000 minus R 27,000 = R 63,000 as earnings. Over 10 years you make R 6. 3 lakh and if you were able to earn compounded return, you would earn about R 8.42 lakh. If you are in the 10 per cent tax bracket you would earn about R 11.8 lakh.

Option 2: Invest interest earned into equity mutual fund SIP.

From your interest of R 63,000 you invest via SIP of R 5,250. So at the end of 10 years you would have earned approximately R 10.23 lakh assuming SIP returns at just 9 per cent compounded. Normally equity funds are expected to generate 15 per cent or more. But just for sake of being ultra conservative and that investments are staggered over time, returns of SIP are assumed at 9 per cent. In this case you still make more than FD's as investments.

Returns in equity funds are tax free as per current rules. If we were to assume SIP returns @12 per cent we would make R 12.20 lakh. As you can see difference is significant if you are in 30 per cent tax bracket. Even if you are in 10 per cent tax bracket you would be better off with this option.

Option 3: Directly invest into equity funds. It would be incomplete to present options without considering the option of 100 per cent equity investment. In this case we can assume returns of about 15. Thus via this option your earnings would be approximately R 30.45 lakh. There is an 85 per cent or more certainty of this happening. There is however a caveat here, which is explained below.

The caveat

In option 3 many would argue that the last 5 years has shown zero or no performance for investment in equity funds. Equity is basically a long term investment and the reason it is said so is because business cycles have

Single Page Format
Ads by Google

More from Personal Finance

Reader´s Comments
| Post a Comment
Please Wait while comments are loading...