Note – I have written about Paying Off Loan Vs Investing for Future debate in detail recently. You might want to read that article –Pay Off Loan or Start Saving & Investing? In this post, I am trying to give a suitable response to mail I received from a reader named Shivangi. A part of her mail is given below:
I have a loan with outstanding amount of Rs XX lacs. I want to save and invest for future also. But everyone in my family and friends are telling me to clear off my loans before even thinking about saving or investing for future. Please advice if this is a prudent thing to do or whether one can clear loan and invest parallely?
To be honest to everyone, I may not be the best person to answer this question as I myself have not been in this kind of situation. But I will try to arrive at some conclusion using rational and common sense as my tool.
Readers are welcome to share their own suggestions for Shivangi in comments section.
Two Important Considerations
One thing which is not known here is the type of loan which Shivangi is referring to. This is important because different loans have different interest rates and different tenures. For example,
Home Loan : 12% : 20 Years
Personal Loan : 20% : 1 Year
Car Loan : 12% : 5 Years
Loan from Family : 0% : Flexible Tenure
And so on…
Another important thing which needs to be considered here is that when one is planning to invest or save, what is the expected rate of return?
This is because if you are paying 20% in interest for a personal loan, and you want to save your money in fixed deposits, which give an after tax return of 6%, then you are really not being financially intelligent.
Once you have knowledge of these two key important pieces of information, i.e. Interest Rate (&Tenure) of Loan and Expected Rate of return for investments, you need to do a little bit of prioritization…
Now this is very important to understand. A loan taken to invest in a property, which brings monthly rent may not be a bad loan. It is creating an asset which in turn will become a cash-generating machine. But if you buy a car at same interest rates, it is a bad loan as the value of car would depreciate with time. And it will not earn you anything during the time you use it (unless it’s a commercial vehicle).
Then there is credit card (type-of) debt. Almost everyone will tell you that credit card debt is bad. And generally speaking, they are right. The effective annual interest rate of credit cards is close to 40%!! So in case you do have credit card debt, you should target to clear it off as soon as possible and with a priority greater than anything else.
5 Steps To Invest & Pay Off Loans Simultaneously
All in all, it is indeed difficult to create an investment or savings portfolio, if you have number of loans running. But it is not impossible. Read the steps below and then I will tell you the most important thing:
First of all, you need to recognize the high interest loans (credit cards, personal loans).
Now if you have any long term, low cost loans (property loan) running, you can think of investing simultaneously as you go on paying off that loan.
And now for the most important and toughest part…
Before you even think of following the above steps, you need to be willing to change your lifestyle as well. And that is because you can only make sensible financial decisions when you are ready to temporarily change and cut down the discretionary expenditures. By discretionary expenditures, I mean buying of goods and services which can be postponed till the time you are financially secure. Just sometime back, I was shocked to know that people are buying wrist watches on monthly installments!! Now according to me that is heights of financial stupidity.
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