Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.He also manages a portfolio on the online platform Kristal. Find link to the strategy named 'The Tortoise'
What is Capital? Capital is our hard-earned money which we save over the years. The next question thus is Why do we save? We save to meet our needs or goals in the future, or perhaps for contingency. Thus we invest the money we have with us instead of spending it, and wait for consumption for a later date.
The money that you earned today could have been spent today only but you chose to defer the consumption to a later date by investing the money. Thus the money that you saved has become your capital.
Now, suppose at a later date you intend to withdraw your money to buy something, the capital you had invested in the first place should have earned enough return so that you could have bought it in the first place. Basically, you are trying to protect the purchasing power of your money in the name of capital protection. What is the biggest risk to capital? It is the rise in prices or inflation. When we say protection of capital, in simple terms we mean that our capital should be able to grow higher than growth in our expenses. This is capital protection. If the rate of growth (returns) of the saved money (capital) is less than the increase in household expenses, then we are simply destroying the capital.
Therefore, the question that arises is: which investment option surely and certainly destroys our capital? The first choice of Indian investors is a financial asset called fixed deposits (FDs). Historically, net of taxes it has hardly ever beaten inflation. A person falling under the 30% tax bracket is surely to earn a post-tax return lower than inflation in the long run.
To cite a simple example, you want to take a holiday package for your family which costs Rs.1,00,000 today. But instead you decide to defer it & put the money in a FD at 7% p.a. After 3 years you will get Rs.1,22,500. After 3 years you decide to go on a holiday again but then it costs Rs.1,30,000. This is a simple example over a short period of time. Imagine what happens with your retirement savings over the next 20-30 years.
You may be saving 20-30% of your salary & suppose over your work life your savings earn say 6-7% post- tax returns p.a on an average (all your savings have been in options like FDs) while your expenses (read inflation) keep growing at 6-7% p.a. After that you have kids and you educate them and also marry them amongst other major expenses like buying a car or a house. When you retire, all you have is your ‘safe’ FDs. You have created some corpus but you may run out of capital by the age of 70. What will you do when you run out of capital at the age of 70? This is what bank FD does to your capital. There is no real growth in capital. Therefore, think beyond bank FDs they hardly beat inflation in the long run.