High risks of playing too safe

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 FD8217;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 known to run in the range of 4 to 7 years.

Thus at about these intervals we in India have witnessed rallies and crashes that have meticulously unfolded. Instead of considering a rather myopic view of last one or two or three years,it would be prudent to understand the history of about 33 years of the Indian stock market. Sceptics would say that history is history and future may be different while believers would say history repeats itself. Anyways here are some numbers to ruminate on.

A month-wise analysis of last 33 years of BSE index from 1979 to May 2012 shows that there have been 338 such 5 year periods. Of these,in about 30 periods returns were between zero or negative. The maximum negative return was 26 per cent. This also means that in 308 such 5 year periods,returns were positive.

Of these 308 periods only in 21 periods returns were below 15 per cent while in 287 periods,returns were in excess of 15 per cent 8211; that8217;s 85 per cent of the times. That8217;s 85 per cent probability that you can make more than 15 per cent in an equity investment.

Similar returns would possibly unfold for real estate as well,just that we do not have credible data to undertake this analysis.

Last words

What might be the average opportunity loss during a working life span of about 35 years? Say if one were to invest R 1 lakh every year for each of the 35 years of work life,in all one would have invested R 35 lakh. Over this 35 year period how would the comparison pan out for a 100 per cent FD investor v/s a 100 per cent equity investor? The potential opportunity loss would be a staggering 9 crores. In other words by investing in conservative investment one has lost about 9 crore which had an 85 per cent probability of fructifying.

This is just based on analysis of the BSE index. Individual stocks or funds or properties would yield much more. Smarter management of money would make this opportunity loss perhaps even larger.

I am not saying that FD8217;s or conservative investments are a bad idea and that equity or real estate is the only way. But considering the larger back-drop of the level of average prosperity across Indian household8217;s,the fact that most people generally never have enough,that most people have to compromise in later years; history shows us certain possibilities that we might want to think about.

Author is Director Transcend Consulting kartiktranscend-india.com