Question: Are there guaranteed investments in the highly volatile stock market?—asked at “Ask a friend, ask Efren” free service available at www.personalfinance.ph, Facebook and SMS.
Answer: There is a strategy that can guarantee investments in the stock market. But please note that this strategy is NOT for everyone. It’s ideal only for people who are so risk averse and who just need to get a taste of how it is to invest in the stock market. Note that you also need to use behavioral economics, particularly “framing”, to get people to espouse this strategy.
Let’s assume a 91-day time deposit (TD) rate is 3 percent gross a year or a net of 2.4 percent a year. Let’s also assume one has P1 million to invest.
If a person were to invest 89.24 percent of his P1 million in the 91-day TD and roll over the principal for five years and have all the interest earnings withdrawn and left in a savings account for the same period, the P892,400 plus all interest earnings will grow back to P1 million by the end of five years.
What does he do with the balance of 10.76 percent of his P1 million? He invests it prudently in a handful of stocks at the start. Hopefully, this stock portfolio will earn a 30-year compounded return of the PSEi of 8 percent a year by the end of five years. But even if the stock portfolio incurred a 100-percent loss, the investor will still be left with P1 million at the end of five years.
As mentioned earlier, this strategy is not for everyone because people who just want TD placements are more likely those who are happy with the attendant low interest income because of their simple lifestyle. Also, such people will probably consume the interest income and not leave it in savings. But let’s talk about those who are willing to espouse our foregoing strategy.
The strategy I am referring to represents the basic operation of principal-protected funds. But as shown, there is no need to enter into funds or contracts. This can be a do-it-yourself or DIY strategy.
Note that while the principal of P1 million will be intact after five years, there are inflation and opportunity losses even if the equity allocation were to preserve its value by the end of five years.
In the end, this principal protected strategy is great for getting people’s feet wet in potentially better inflation-busting returns (as good returns from the stock market can encourage them to allocate more to stocks). The trick is to make them think they are espousing a strategy of at least preserving their P1 million by the end of five years and that any addition to it at the end of five years is the proverbial icing on the cake.
Finally, note that the guarantee on the fixed income instrument, TD for example, is only as good as the guarantor. So, be prudent with the fixed income component of this strategy as well.