What capital guaranteed products offer

If you are a conservative investor, the first question that will pop up in your head while making an investment will be “will I get a capital guaranteed return?”

Currently we have enough products in the market that give returns along with capital protection. But how do you decide which product is the best?

Considering that the main concern is to keep the capital protected, conservative investors should first look at an investment option wherein the capital will be 100% safe. There are two kinds of instruments in the market: fixed capital guaranteed products and products that aim to protect capital, however, doesn’t promise a guarantee. Under the fixed guaranteed instruments, you have some of the popular products such as fixed deposit (FD), post office time deposit, Public Provident Fund and National Savings Certificate. Capital protection-oriented mutual fund (MFs) are products that aim to protect the principal that you invest in. To give a true picture of returns from these instruments, we compare capital protection-oriented MF with FD and here is what we found.

Capital protection-oriented MF

Capital-protection-oriented MF is considered the safest bet in the MF basket. For calculation purposes, we have picked the funds that have completed the three-year lock-in period. According to Value Research, almost 10 capital protection-oriented funds entered in 2007 with new fund offers have completed the three-year lock-in period. All the capital protection-oriented fund have given 100% guarantee on capital. No fund house has lost the principal amount that has been invested. Also the highest return generated was 9.11% in a capital protection-oriented fund at the end of three years since the launch date, showcasing its ability to generate positive returns or real return after accounting for inflation. Assuming three-year inflation is at around 6%, the real return after accounting for inflation in case of this fund will be 3.11%. Says Srikanth Meenakshi, founder and director, FundsIndia.com, “Capital-protection-oriented funds invest in coupon rate debt papers and gets 100% returns from it. Hence, your capital will be 100% protected considering that the underlying assets of these funds are government papers. Though these funds give guaranteed returns, the fund houses don’t says so because some percentage of these funds will be either in equity, gold or derivatives.”

They are also prohibited by the Securities and Exchange Board of India (Sebi) to assure returns. Sebi states that capital protection-oriented scheme shall disclose that the scheme is “oriented towards protection of capital” and does not offer “guaranteed returns”. It shall also be indicated that the orientation towards protection of capital originates from the portfolio structure of the scheme and not from any bank guarantee or insurance cover.

Tax treatment on these funds is a bonus as you get a post-tax return as high as 9.06% on a fund that has given a return of 9.11% if calculated based on 20% tax with indexation.

The gains from capital protection-oriented funds, if held for more than one year, are considered as long-term capital gains. Hence, the tax treatment for long-term capital gains will be applicable: the long-term capital gains are taxed at 10.3% without indexation or 20.6% with indexation.

Fixed deposit

Bank FDs are believed to be safe and easy to understand. However, no matter how high the returns are, the tax treatment is such that the amount you get in hand will be lower. Also after factoring in inflation, the real returns will most likely be very low.

Consider this: In 2007, State Bank of India’s FD rate for a tenor of three years and above was 9% for up to 15 lakh. If you had locked in this FD for three years, for an individual falling in the 30.9% tax bracket, a 9% annual return would get reduced to a net return of 6.21%. If you are in the 20.6% tax bracket, then your net return will be 7.15%. For those who are in the 10.3% tax bracket, the net return will be 8.07%. After factoring in the inflation, the real return would have come down even further to 0.21% for individuals in the highest tax bracket, assuming three-year inflation at 6%.

Three-year time deposit

We also looked at three-year post office time deposit. Though this product gives you a capital guaranteed return, the post-tax return will be much lower as the tax treatment is on slab rate. Hence if you are in the highest tax bracket, a return of 8.30% will fetch you 5.74% post-tax return.

What should you do?

All these products have protected the capital and have given positive returns, therefore the point of comparison for conservative investors will be the post-tax returns or the returns that you get in hand. Says Suresh Sadagopan, a Mumbai-based financial planner, “Considering that the capital protection-oriented MFs invest more than 80% of the funds in government securities, your capital will be protected. So by taking a minuscule risk coupled with the tax benefit, chances are that these products will give you higher return than bank FDs.” Keep an eye on the benefits of capital gains tax treatment and you will earn more returns.