Can I invest in such a way that my capital is protected?

Published: November 7, 2016 at 3:12 pm

Last Updated on December 18, 2021 at 10:55 pm

‘Can I invest in such a way that my capital is protected?’ is a question that many ask. Especially those who are retired, or about to retire. The answer is contextual. The term capital protection can take two meanings depending on how we use it. In this post, I discuss the disadvantages of capital protection, when one should do it and what are the alternatives.

 First A request: Please review You Can be Rich Too With Goal-based investing at Amazon or Flipkart. It will help us become better writers. Here is the first review at Amazon.in 🙂 If you have not got it yet, order one today!

review-1

Protection against erosion: In its simplest and most popular form, if I have invest one lakh today, the investment should not erode that capital. Or in other words, the capital invested should be intact at all times (protected against loss). Capital protection against erosion is essential in certain situations and is easy to achieve.


Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

Protection against loss in value: Rs.1 lakh today will still be Rs. 1 lakh twenty years from now. However, its value or what we can buy with it would be considerably less. As you know, this is due to the effect of inflation. Capital protection against inflation is essential but not easy to achieve after retirement. A part of the corpus must be able to fetch a real return to enable this and real returns imply taking on volatility. Real return refers to excess return above practical inflation after taxes. How much volatility exposure a retiree should take on is, however, debatable.

I have suggested some guidelines earlier on when erosion protection is essential and when value protection is possible: When should senior citizens purchase an annuity?

The problem in both cases is inflation and sudden changes to lifestyle resulting in recurring expenses.

If my corpus is too low that I cannot afford to take on risks, I am forced to protect my capital against erosion and completely unprotected against inflation (loss in value).

If my corpus is comfortably large, then I can combat inflation and ensure that it outlives me.

The danger is when it is neither too small nor too large (these limits are arbitrary!), then it is a see-saw between erosion protection and inflation protection and if one gets it wrong, it can be a problem.

Can these two protections be combined?

If the retirement corpus grows year after year by an amount which is exactly equal to the amount we withdraw for expenses, then we have achieved capital protection and value protection. This is known as a perpetuity. An illustration can be found here: Is it possible to retire early in India?

Achieving this in a country with high inflation is quite difficult and if there are sudden withdrawals, the plan will go phut.

In response to Generating an inflation-protected income with a lump sum, Mr Lakshminarasimma had asked an interesting question which made me write this post:

assuming only you and your wife are there and you have 90 lakhs after doing all marriages college education of your children. also assuming you have physical and mental strength

put entire 90 lakhs in FD, get monthly 55k post tax as interest at 8%, manage 35k expenses and some 15k keep putting in mutual fund. keep 5k as reserve

in this way your capital is protected, you manage monthly expense, also you invest still in share market like subra says.

Will this work? Can capital and value protection be combined by investing the corpus in risk-free assets, live off part of the interest and invest the rest? Let us find out.

Assuming for a moment it is possible to find a risk-free instrument that offers 8% return before tax (at 10.3%)* for 20 years (it is not possible, but please humour me for argument’s sake), this how it will pan out ideally!

capital-protection

* It should be 20.6%, making things worse but will not change the main idea.

Assuming a conservative inflation rate of 6% (unrealistic), within 9 years, the expenses will overtake the interest from the “risk-free” instrument – notice how risky this really is!! And we have assumed for 20 years, there will be no unknown expenses!!

Capital protection is possible after retirement, but at what cost?!

So what should be done? In this case, the initial withdrawal rate is 4.67% (12 x 35,000/90,00,000). This is pretty decent and the retiree can afford to stomach some volatility. Using the Four Simple Retirement Planning Tools (app version coming soon), one can find out that 90 Lakhs, at 8% inflation and a net portfolio return after tax of 7% can last for 19.6 years (after which it will be exhausted)

There are many ways to achieve this comfortably. Using the ideas discussed in deciding on asset allocation for a financial goal, suppose I decide to invest 70% in risk-free fixed income and 30% in say, equity-oriented balanced funds (which I consider as 100% equity).

I expect 6% post-tax from the fixed income instrument (reasonable for now?) and 9% from the equity balanced funds (conservative?)

Then  70%x6% + 30%x9% = 6.9% Which should be enough.

This is a comfortable situation owing to the availability of 90 Lakhs and expenses (initially) only 35K a month. The trade off between capital protection and volatility is easily achieved.

If I had only 80L, then for the above assumptions, the corpus will only last 17+ years. To make it touch 20 years, I will have to obtain more return. Meaning, I will have to take on more volatility.

With decreasing corpus or higher expenses, the trade-off will become harder and harder until I cannot take on any risk.

For example, suppose I had only 50L, my monthly expense is 25K then I will need about 10% return from the portfolio after tax to make the corpus last for 20 years with 8% inflation.

And how will I get this 10% return?

Fixed income 50% with 8% expectation after tax and Equity 50% with 12% expectation. Is this reasonable? Not in my book. A single market crash and I ruined. In such a case capital protection is mandatory!

So to sum up, sometimes capital protection is dangerous, and sometimes necessary. Sometimes one can balance between safety and volatility and sometimes one cannot! Check out the following posts to get a better understanding of the ideas discussed here:

When should senior citizens purchase an annuity?

Generating an inflation-protected income with a lump sum

Illustration: Generating inflation-protected post-retirement income

Inflation in India: Some Real Numbers

Inflation-protected Income Simulator

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)