How Kisan Vikas Patra offers assured 12% returns?

I was visiting the post office the other day to enquire about the Senior Citizens Savings Scheme.

The friendly person at the desk mentioned that since the rate is going to be revised lower from April 1, 2016 there has been a huge inflow recently into the scheme.

I agreed with him and said “Of course, everyone wants to lock in at the higher rate.”

“Not just that even Kisan Vikas Patra or KVP has witnessed a huge surge in investments, to the tune of several crores.”, he mentioned with a delight.

I was curious and asked why would that be? Kisan Vikas Patra was not even an option I considered for investments.

“Simple na, it doubles your investment in just 100 months. Who wouldn’t go for a thing that offers 12% assured returns.”

Now I was taken aback. 12% assured returns on Kisan Vikas Patra? This is not what I know? Or is this a new form of KVP that has been introduced.

“How is that possible? 100 months means about 8 years and 4 months. The interest rate would be only 8.7%.” I was secretly using my thumb rule of 72.

“No no. You are getting 12% return, assured.”

“Sorry, I don’t understand how.”

“I can see that.” he had an air of intelligence on him.

“See, if you invest Rs. 1 lac today, you would earn Rs. 1,000 per month for the next 100 months. What is 1,000 of 1 lac?

“It is 1%.” I answered like a good student.

“Exactly. For 12 months what would it be?”

“12%.” A quick answer to prove I was smart.

“See, you yourself calculated 12%.” I was flowing with his explanation.

For a moment, it struck me as if what a fool I have been to ignore such an awesome, assured return investment that too backed by the Government of India.

But the next moment, I got my senses back.

I told him “Sir, you are showcasing it as a simple return. it does not account for compounding”.

“Of course, it does. It is 12% on a compounded basis.” he was adamantly sure. “You are not getting it”, he had a little frustration on his face, of having to deal with a dumb guy.

“I will need time to think about it.”

“Take your time.” He said as he got up. It was time to leave for the day.

“By the way, now the Kisan Vikas Patra will double money in 110 months.” he further added.

I thanked him for the information and walked out. My mind was ticking and filling excel sheets already. I had some homework to do.

Do you also feel convinced about Kisan Vikas Patra giving a 12% assured return?

If you did, then like me, you also fell prey to as fallacy – presenting an argument in a way that you start to believe in a different world view or view point.

The Kisan Vikas Patra actually works like this

 

The Yearly Increase and Increase per month column are only for reference.

As you can see, the gentleman at the Post Office averaged the gains and presented it in a way (Rs. 1,000 per month) to make Kisan Vikas Patra sound wildly lucrative offering a 12% interest rate. The actual rate is just 8.7% per year.

No doubt several investors were caught in this fallacy and invested crores in an instrument that may not serve their financial goals adequately.

The Kisan Vikas Patra argument is not an isolated case of such fallacy.

Years back, I got a call from a foreign bank’s credit card division convincing me to take a personal loan at a rate of just 10.05% per year.

I had by then been into the financial world for some time and knew that this was an impossible rate to offer on a personal loan.

I enquired further about EMI, payment terms, etc. What emerged was this.

The truth about personal loan interest rates

As you can see, the entire interest paid out during the tenure (F) was averaged out (G) to show a 10.05% interest when actually the rate was 18%.

Easy to fall for, right?

How do you save yourself from such fallacies?

Clearly, you have to understand how the magic of compounding works. There can be no 2 ways about it.

There is a reason compounding was declared as the 8th wonder of the world by none other than Einstein.

Here is the post you can refer to.

Finally, always ask questions and more questions.

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Between you and me: Would you invest in Kisan Vikas Patra? What other fallacies have you come across? What did you do? Do share with me.

Want to know more about investment in Kisan Vikas Patra. Click here.