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Capital Guarantee Plus Appreciation?

Sandeep Shanbhag explains how you can get “assured” returns: by putting a part of your capital in a fixed income instrument like National Savings Certificate (NSC) and using the remaining to invest.

The example he uses is: If you have Rs. 6 lakhs, you can put Rs. 3,78,000 in an NSC at 6% and the remaining into a mutual fund (Rs. 2,22,000). The NSC, after 6 years, yields Rs. 6 lakhs, so your capital is secure. Whatever you get from a mutual fund is a bonus!!!!

Sandeep goes on to prove that if you had done this in 2000, you would have earned Rs. 25 lakhs from that 6 lakh investment!

Is this really something you should do? Uhm. I beg to differ. There are things you need to consider before you really invest.


Prices go up about 5-10% every year, and so do rents, salaries etc. So Rs. 6 lakhs will buy you a lot lesser after 6 years than it does today. In reality, let’s take 5% as an inflation rate; what will 6 lakhs need to grow in six years, so that it buys what it can buy today?

Answer : Rs. 8.04 lakhs.

To get Rs. 8.04 lakhs in an NSC after 6 years, you have to invest Rs. 5,07,000.

Okay, you think, so what? I still have Rs. 93,000 to put in a mutual fund, right? Uhm. Yes, but you must consider:

Income Tax

(To his credit, Sandeep does mention he hasn’t considered tax)
NSC earnings are chargeable to income tax. For the top bracket of 30%, you will have to pay around Rs. 90,000 over the six year period for that Rs. 5,07,000 invested. Now NSC Income is reinvested and the extra investment is non-taxable under section 80C, but I will assume that you will have used up the 1,00,000 limit through other methods, and that this income is taxable.

That means, nearly all the extra money will go into tax!!!! But then you still can invest the 93,000 and hope it will grow so much that you can pay off the tax and still have something left over right? Tax is payable every year, so this is the schedule:

Year       Tax to be paid
1st Year : 12,168
2nd Year : 13,141
3rd Year : 14,192
4th Year : 15,328
5th Year : 16,554
6th Year : 17,878

If your Mutual fund goes up by 16% EVERY YEAR, you will just about break even after paying tax; you will end up with Rs. 99,000 after paying all the taxes.

To summarize: If you have Rs. 6,00,000 and you invested Rs. 5,07,000 in an NSC at 6% and Rs. 93,000 in a mutual fund that returned 16% a year, you will have Rs. 9,01,000 after six years (considering you pay out taxes).

Inflation means your Rs. 6,00,000 today is equivalent to Rs. 8,04,000 after 6 years. So your real gain, in six years, is only Rs. 1,00,000 (One lakh).

That’s not as attractive as the 18 lakh return Sandeep mentioned. But that is really the ONLY way have a “capital guarantee”; you should be guaranteed against inflation AND tax, not just on your money today.

What if you consider tax saving as well? The initial corpus of 6,00,000 saves you tax – at 30% of the 1,00,000 80 C limit – which can go into the mutual fund! Let’s also assume that the NSC interest is tax exempt (as part of future 80C contributions), only the last interest (Rs. 60,000) is taxable.

Then your corpus in the fund goes up to 8.04 lakhs (NSC) + 2.66 lakhs (mutual fund) totalling Rs. 10.7 lakhs. You have a tax on the last interest payable at Rs. 17,878 so your net corpus is Rs. 10.53 lakhs.

This is a much better figure – corresponding to about 10% annualised growth, and post inflation growth of about 4.8%. But that is a very positive estimate, considering your mutual fund goes up 16% – any lesser and your returns go down. Plus, now that you have all this money in 80C taken away, you lose that much opportunity to save tax elsewhere.

I hope this has provided you with more perspective about the real meaning of capital security. You have to think Post Tax, Post Inflation.

  • Anshul Gupta says:

    >Hi Deepak,

    check this article:

    MF houses are trying to use the same strategy which Sandeep Shanbag is talking about.
    Infact, there can be no post tax,post inflation capital guarantee plan.
    There are certain capital guaranteed ULIP which assure you atleast the premiums paid plus interest @ 2.75 CAGR.Do you have anything to say on that?


  • Deepak Shenoy says:

    >Anshul, There’s the PPF which is the only “capital guaranteed, post tax and inflation” plan: 8% interest, where interest is also tax free. Downside of course, is investment limits and liquidity, but that’s not too much of a problem.

    I don’t believe in capital protection; I think people shoudl focus on returns post-tax and post-inflation. If your fund guarantees you anything, even the ULIPs, you can be rest assured that their guarantee will be lesser than inflation+tax adjusted minimum required growth. And in order to make that undesired guarantee they will be too conservative and limit your upside also.

    THe best thing, after PPF, is to invest in funds that have no guarantee but have, in the past, given about 6% dividends, meaning tax free post inflation positive growth. The important thing is “no guarantee”; the minute they guarantee you even 1%, your upside is gone.

    I’ve invested in the HDFC Long Term MIP Dividend plan for this. Let me see how it goes.

  • Anonymous says:

    >I was thinking, if we invest only the intrest part of the earnings in MF as a SIP, we are protected to some extend. But calculations will show that results are far inferior to the lump sum investment suggested.

    Another strategy is to assume that MF investment wont go as low as 50%. (it is not that it is going to be zero.. right?). So invest 277 K in NSC, invest 322 in equities. Your 277 will earn about 160 K , about half of equity investments. Thus protecting capital and allowing better appriciation opportunity.

    So a balance fund is in fact much closer to this calculation…

  • Deepak Shenoy says:

    >No, you miss the point. Your capital is not protected post tax and inflation. Consider that and you’ll find you need a lot more money (NSC interest is taxed and inflation is extra)