What to do with your bonus? Read on

October is an especially dangerous month to speculate on stocks. The others are July, January, September, April, November, May, March, June, December, August and February. Mark Twain was never more right.

However, Diwali came and the markets were on fire. Post-Diwali, stocks are hotter than the weather outside, and you are just itching to invest your Diwali bonus into your favourite stock or equity mutual fund. True, at the back of your mind, there is this small discomfort, which is also known as risk. No one has seen what tomorrow brings and what if things don't go as expected?

But there is a way that you could invest your bonus into equity and yet not undertake the risk of losing your capital.

Sometime back, I had written about one of the ways to do that. (Also read - How to invest in stocks WITHOUT any risk) The idea was simple yet effective. Invest your entire capital in a fixed income scheme and invest the returns from this into equity. This way your capital remains intact, yet you can benefit from the equity upside, if any.

However, some investors aren't too enthused by the idea of salting away small amounts for all of six years. Like one of my readers, Mr Shrinivas Kulkarni, who is responsible for planting the seed of this article in my mind.

The idea is simple. You have a lump sum and you want to invest it now, however, with minimal risk.

This too is possible.

Numbers being easier to understand, lets assume similar numbers as were used in the previous article. Note that the figures used are not important, the concept is. If your investment amounts are different, invest proportionately. (Also read - How to become a millionaire)

Lets assume that you have received a Diwali bonus of Rs 600,000. You want to invest it well, preferably in equity, but with minimal or no capital risk. I like the sound of the words "with no capital risk" more than "with minimal risk". So let's devise a strategy of investing a lump sum in equity with no risk.

Here's what you should do. Out of Rs 600,000, invest around Rs 378,000 in National Savings Certificates @ 8 per cent p.a. This Rs 378,000 invested would grow to Rs 600,000 in six years time (the term of NSC). The balance capital in your hand is Rs 222,000. (Rs 6,00,000 – Rs 3,78,000).

Now, invest this Rs 2,22,000 in an equity mutual fund. You must realise that no matter what happens to the money invested in the mutual fund, at the end of six years, the capital invested in NSCs will net you Rs 600,000, which is what you originally started out with. The market value of Rs 228,000 invested in equity is just additional icing on the cake.

For ease of understanding and not wanting to compromise simplicity over accuracy, I have left out the tax angle for the time being. And anyway, NSC interest is deemed to be reinvested, so as such it is not taxable except for the last year. This article is anyway not about taxation, so it suffices to say, that you earn 8 per cent p.a. on your fixed income investment in NSCs.

To see how this strategy can actually work out, we ran some numbers. Say you started your NSC account in September 2000. The balance amount was invested in Reliance Growth Fund on a lump sum basis. Rupees 222,000 invested in Reliance Growth in September 2000 would have grown to Rs 19,50,000 in six years time. Tax-free. Add to it the NSC capital of Rs 600,000 and the total investment would have net a cool Rs 25 lakhs (Rs 2.5 million).

This is Capital guarantee plus capital appreciation.

Now, for a moment do not assume that I am implying that such returns would be repeated in the future. It is possible and at the same time it is not. However, readers will appreciate that there is no way of trying to judge the future except by the past. All I am saying is that such a structure ensures that no matter what happens to the equity investment, the base capital that you had begun with stays intact.

The new capital guarantee schemes that are being launched shortly use a similar mechanism. However, note that none of the fund houses actually guarantees that the capital is protected. Instead a credit rating agency assigns a rating to such schemes that signifies a high degree of certainty regarding timely repayment of the face value of the investment.

Note that the structure explained in the article, if adopted by the investor, essentially guarantees his capital. There are no 'degrees' of certainty involved, just plain old pure certainty. As certain as the NSC investment.

No wonder they say, a steady job and a mutual fund is still the best defense against social security.

The author is the Director of A N Shanbhag NR Group, a Mumbai based tax and investment advisory firm. He may be reached at sandeep.shanbhag@moneycontrol.com