Some people believe debt is synonymous to trouble. They stay clear of loans and credit cards. It is commonly said, “Don’t give up your SIP for EMI”. But they aren’t as despicable. Our reader, Mr. Vinay Pathak, wrote to us asking when taking a personal loan would be better than liquidating investments. This article is in response to his query.
Floods in Chennai or Earthquake in Gujarat, stock market crashes leading to huge losses in market cap and wiping out businesses completely, or sometimes a medical emergency limits your capacity to earn money. Either ways, you lose your belongings and earnings and are left with a huge list of things to buy to restart life from scratch.
When cash strapped what is it that comes first to mind? Whether you must withdraw those FDs, liquidate your mutual funds, dissolve other investments or borrow funds. Which is a better choice? Let us examine through these alternatives.
Financial management demands investing according to one’s risk appetite and personal financial goals. For short term needs make short term investments, for mid-term needs make medium term investments while for long term needs such as retirement, child’s marriage etc. make investments in instruments with substantial returns at the end of a long period.
There are several instruments for investing money. To meet short run & mid-term goals, people keep money in bank accounts, make short term fixed deposits, short term mutual funds, invest in capital markets etc. These are almost liquid investments. For goals with long term horizons people buy retirement plans, invest in gold assets, purchase property etc. These are less liquid investments.
When an emergency arises it would be easy to withdraw your short term and mid-term investments but it may not be possible to dilute your long term investments. For example, you may not be able to sell off that plot and get money even for the next three months. However, to fulfil needs immediately you cannot wait for three months. At such a time taking a personal loan would make more sense than waiting for funds to arrive.
Owing to the magic of compounding, the returns are higher with higher tenure. Thus, it is never prudent to go after your retirement plans or sell properties to make up for exigencies. Try to avoid disinvesting in illiquid instruments. Rather taking a loan against such instruments sounds wiser. By not disturbing such investments you save for long term plans.
Another reason is that by taking credit, even for small amounts, helps you build a strong credit score. For people who do not indulge in debts at all have no score which is not favored by lenders. Taking a personal loan instead of liquidating investments shall help build credit.
While some might argue that when times are not bright then taking on the responsibility of a loan could add to the woes. Infact, when the going gets tough and you don’t know where to go then personal loans can offer respite. They are easily available, the proceeds can be used for multiple purposes and no collateral is needed. In spite of the high rate of interest,they are the most popular type of loans.
Some people are so risk averse that their entire investments are in debt products such as FDs and PPFs. Some instruments may not allow partial or premature withdrawal. For example, with a PPF account you cannot withdraw more than 50% before 4 years. Even from the fifth year, the amount may not be sufficient to meet your needs. Plus, you end up destroying the age of your investments.
Summarizing in brief
We save for rainy days. We save to secure our future. With that comes mental peace. It is never easy to part with your hard earned savings. The sum invested earns interest and dividends, builds assets for long term and secures the future of a person.
One of the important principles of financial management states to weigh all options and do a cost–benefit analysis. As long as it is cheaper to liquidate your investments than pay interest one must consider withdrawing savings. However, when you are forgoing more in returns and dividends than the interest paid then consider taking a personal loan instead.
For example, when you take a loan you pay interest from 15% to 25% whereas an investment in mutual fund could result in returns higher than 15% - 50%, given the favorable market conditions. If the investment was in pure equity products then the returns can be exponential while the rate of interest you pay will remain capped at 15% - 25%.
Thus, while withdrawing your investment in short term products could be advisable, you must take a personal loan before disinvesting in long term investment vehicles.
About Credit Sudhaar
Credit Sudhaar is India's first credit and finance platform for consumers which provide various credit and financial tools such as free credit score, credit monitoring, credit score simulator among others. Credit Sudhaar also provides a wide range of analytical assessments to the users helping them to have an in-depth understanding of their credit health. More importantly, not only does Credit Sudhaar extends guidance on how to improve CIBIL score but it also extends personal loan for CIBIL defaulters apart from facilitating access to various loans and credit facilities based on current credit health.