Pay Off Loans or Start Saving & Investing?

Payoff loan or Invest Save
Should I pay off my loans or invest for future goals? Or should I simultaneously tackle both?
This and similar questions belong to a class of debate (Pay off Loans Vs. Invest), where to be honest, there is no one perfect right side to choose.
Readers of Stable Investor regularly send me questions on this topic and when I got another one yesterday, I thought maybe I should write something about this debate again. I have already written about it earlier here, but that was long time ago.
Before I share my thoughts, let me confess something upfront. I don’t like loans.
I am somehow unable to like the concept of borrowing, even though I completely understand that smart people can use leverage to make some serious money.
Generally, Indians are taught to avoid debt. That is how most of us have been brought up (exception – industrialists 😉 ).
And till few years back, many people looked down at the concept of borrowing.
But ofcourse things are changing. Slowly but steadily, we as a society are moving towards accepting the idea of preponing realization of our financial goals, with the help of loans. Very recently, a cousin of mine purchased his first real estate asset (a 3BHK flat) in a decent location in Bengaluru. Ofcourse it was with the help of a ‘big’ loan. And he is only 30 years old. Would this have been possible earlier (may be 15-20 years ago)? I don’t think so. So things have changed a lot indeed.
Now coming back to our discussion…
The question of whether to pay off the loan or invest is a very common dilemma. More so for people who have taken housing loans few years back. At that time, they took a loan, for which they could somehow manage to pay their EMIs. But with the increase in income during the next few years, they now have the ability to pay back more every month, if they want to.
Example – A person had an EMI of Rs 20,000 in the year 2011 when he was earning Rs 70,000 a month. Now after 5 years, his income has risen to Rs 1.2 lacs a month. So assuming (for simplicity) that his EMI is almost the same, he can comfortably choose to increase his EMIs. Isn’t it?
That is true.
But housing loans are way cheaper than other forms of loans and given the additional tax-benefits, there does seem to be a mathematical case of not repaying the loan early – as effective loan rate is reduced further.
The extra money can instead, be invested in products that are historically known to give average rates of return that easily beat effective loan rates. I am referring to long-term investments in equity mutual funds.
Ofcourse there is no guarantee here. But chances are pretty high that average returns (if you stay invested for long enough) will be pretty decent.
I think the above discussion is more general and its better if I get down to the specifics…
So lets consider a scenario.
What if you have a home loan but unfortunately, almost no savings whatsoever? Whatever you have in the name of saving, is also locked up in long lock-in products like PPF.
In such a case, it’s a no brainer. Forget about paying off your loan.
Irrespective of what mathematics and online prepayment of home loan calculators tell you about interest differentials, you should carry on the loan as it is and start saving some money first. As I said, don’t worry if returns from your savings are even lesser than effective home loan rates.
Just start keeping aside some money into a sort of emergency fund. And once you are out of the situation of zero-savings-lots-of loans, only then you should think about whether to start prepaying your loan, invest for future goals or even think about getting into the home loan vs. mutual fund debate.
But wait… why are we just focusing on home loans? There are many other kinds of loans too.
So what if you don’t have a home loan, but instead have a car loan, or a personal loan or some credit card debt?

When it comes to these types of loans, it’s better to take help of mathematics. The reason is that these are very costly forms of loans.

Credit cardsCosts more than 40% interest
Personal loansCosts more than 15% interest
Auto loansCosts around 15% interest
Now there is no easy way to invest your money where you can be assured of getting more than 15% returns every year.
Equity MFs have given better returns in some cases, but the returns are not stable. It can be +50% in one year and -20% in another. And you don’t want to be caught on the wrong side here. Average returns are better but as I said earlier, there is more to just quoting average return that meets the eye.
So, if you have credit card debt or a personal loan, repay them first. Clear them off as soon as you can.
Note – The earlier stance on having some savings as emergency fund still stands. That’s a non-negotiable.
The need is to prioritize your loans according to interest rates and clear them off.
I have seen people paying minimum dues on Credit Card, which means they are paying 40% interest on their credit card outstandings and still investing in stock markets.
That is outright foolish unless they can prove that they will earn better returns from markets than they are paying on credit card dues. 🙂
Here, I would like to return to the emergency fund discussion again. Whether you repay your loan or you invest for future – should depend primarily on how exactly is your emergency cash situation.
Do you have a stable job and have the money to take care of short-term expenses (both expected and unexpected)? Think about it.
Another point to note is that when we choose to invest instead of repaying the loan, you are betting on the fact that your investments will necessarily do good. That’s easier said than done my friend. There are so many things that can go against you. Wrong choice of fund/stocks, markets going into a free fall, etc.
I am not saying its wrong to invest, when you have a home loan running. I am just saying that you need to be aware of the risks you are taking.
I am sure many of you would be thinking that I have still not said a word about the emotional and psychological aspect of clearing off loans. 🙂
So here it is…
Is prepayment of home loan beneficial?
The answer depends on the chosen aspect – mathematical, emotional or psychological.
But yes, it’s a great feeling to have Zero loans – no doubt.
And it allows you to sleep well too. 🙂
No amount of maths can capture this benefit in any form. So if you like me are debt-averse and prefer peace of mind to interest arbitrage, then you should pay off your loans. Don’t worry about what others are thinking about you.
You have the right to extract most units of happiness from your money. 🙂
Paying off loan also makes sense when you think about the risk of job loss. So your (and your spouse’s) job stability should also be a factor when you are thinking about prepaying or not prepaying your loans…
…as defaulting is not an option – unless you are the now-supposedly in London – King of Good Times. 😉
If you are targeting early retirement, then once again it makes sense to close out your loans quickly. But if you intend to retire at a normal pace (around 60), then investing for your retirement should also get a very high priority – somewhat similar to that given to servicing of loans.
It has already become a very long post now. My apologies.
So let me quickly list down a few points that will help you keep track of the above discussion.
Whenever you have enough surplus money to ask yourself the question – whether to pay off loan or to invest, think on these lines (in the given order):
  1. Your first priority should be to have a big enough emergency fund in place – which can take care of any unforeseen money requirements
  2. Identify all loans with very high-interest rate (like credit cards)
  3. Get rid of them as soon as possible.
  4. Identify other high-interest loans like personal loan, car loans, etc.
  5. Also, identify low-cost loans (especially home loans).
  6. Under most circumstances, you can continue to invest and simultaneously pay off low-cost loans.
  7. As for the high-interest loans (personal and car loans), it depends on how much is the available surplus and what are the effective rates of interest. Mathematically, it might make sense to pay off these loans first, but you can take your own call.
On a personal note, if I have a personal loan that I am able to service comfortably + I also have some surplus money every month + there is big market crash where there are clear indicators that investing would make sense for long term, I will go out and invest my surplus in markets instead of paying off loan. Sounds risky, but that is for me. 🙂
But in case I have credit card debt (very high rates) in the above situation, I will make sure to clear it off first before investing in markets.
So as you can see, this question has no one right answer.
You can use some pay off your loan or invest calculator and come up with a mathematical (theoretical) answer. But in reality, it depends on many other factors like borrower’s exact financial situation, risk capacity, risk preference (appetite) and available alternative opportunities.

You are the best judge of whether you should pay off loans, save or invest or balance the two. Give it some serious thought if you are in that situation.

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How much Life Insurance to Buy & How To Calculate the Right Amount?

How Much Insurance To Buy

A reader had a very specific question in Personal Financial Concerns Survey 1.0. It was about calculations related to life insurance amounts.

This is what he had to say:

In past, I have bought insurance policies for saving taxes and investments. But now I understand that these should not be the main reasons for buying insurance. Hence, I want to buy the right insurance cover to secure my family. How much cover is enough for me? People say buying Rs 50 lacs or Rs 1 Crore coverage works. Is it correct?

Now that’s a question that many people have.

I have seen people earning in 7-figures and having insurance cover of 6-figures! 🙂 They believe that a 6-figure amount will be sufficient to take care of their family in case of their death. And these people don’t even have a lot of money saved up.

Tells of risks that people take with their family’s future.

Insurance is bought simply to ensure that insured person’s family does not have to make sacrifices with their standard of living, are able to achieve their future financial goals and close all outstanding loans. That’s it. Nothing more. Nothing less.

But I am not writing this post just to prove that buying life insurance is a must. I am rather concerned about addressing the reader query, which is:

How much Life Insurance to Buy?

It is not that difficult to calculate.

You life cover should be sufficient enough to take care of the following 3 parts:

  • Provide enough money to foreclose all outstanding loans
  • Provide enough money to help meet regular day-to-day expenses of your family for years to come.
  • Provide enough money for your children’s education and marriage.

Lets take them up, one by one…

Part 1: Provide enough money to foreclose all outstanding loans.

This is pretty simple to understand. Just make sure to add any foreclosure charges that have to be paid in case of loan closure.

Lets call this as Amount-Loan-Closures.

Part 2: Provide enough money to help meet regular day-to-day expenses of your family for XX number of years to come.

(Caution – You need to be really sure about what XX is here – as it is the number of years, you think your family needs to be financially supported).

If you think your working spouse will take care of this part on her own, then that’s debatable. Just remember, that in a dual-income family, life style costs and regular expenses generally increase to use a larger part of the combined incomes.

So if suddenly one income stops, it can become a big problem to maintain the existing lifestyle.

Hence, it’s better and safer to make a provision for this as well.

Now how to calculate this amount?

Step 1: Estimate regular annual family expenses (exclude your individual expenses).

Step 2: Subtract the amount you think your spouse can manage on their own (better keep this as minimum)

Step 3: Understand that multiplying the above amount with the number of years (XX above) you wish to support your family won’t work. Why? Inflation. Inflation will increase these expenses every year. So take a safe inflation assumption (say around 8%).

Step 4: Understand that the amount your family gets from insurance company, will be invested and used to generate income. Don’t expect very high rates of returns from the investment. Lower your expectation are, better it is.

Step 5: Use this information to calculate the required insurance amount. This amount will provide enough money for your family to meet regular day-to-day expenses for the XX number of years.

Lets call this as Amount-Family-Expenses.

Part 3: Provide enough money for your children’s education and marriage.

Now it’s a personal choice here – Do you want to provide for your children’s education or marriage needs or not?

Assuming you want to, lets see how to arrive at this figure.

Step 1: Estimate the amount required for your children’s education and marriage, if it were to happen today.

Step 2: Since you children need funds in future, understand that inflation will increase the amount required. So if a MBA from good college costs Rs 15 lacs today, it might cost Rs 35-40 lacs after say 10-12 years. Calculate the amount in future using inflation numbers.

Step 3: You might have already saved some money for these goals. Calculate the future value of these savings and subtract the figure from amount calculated in above step.

Lets call this as Amount-Child-Goals.

 

Now we have calculated 3 figures for each part.

Add these three figures:

= Amount-Loan-Closures + Amount-Family-Expenses + Amount-Child-Goals

This is you current insurance requirement.

But you don’t stop here.

I am sure that you have been careful in your calculations.

But you see, in all calculations above, we had to make certain assumptions. Assumptions that require us to make predictions regarding rate of inflation, rate of return, etc. Now you know that even experts have trouble predicting the future. So at best, our predictions are mere educated guesses and not future realities.

We can always be wrong in our assumptions.

So in order to provide a buffer for mistakes in our assumptions, increase the amount you calculated above by atleast 10%.

Higher you bump it up, better it is.

I personally take it at 25%. (Even if it means that you family ends up with more money than they actually require, it is a good problem to be in. Isn’t it?)

This is the Gross Insurance Requirement for you.

Once you have calculated the figure, you need to subtract a few things from it. You might already have some other insurance policies,  employer-provided insurance covers, existing savings and investments earmarked for some of these child_goals . Subtract these amounts from above figure.

This will give you the additional insurance cover you need to purchase.

You can use the following grid as a guide:

Life Insurance Calculations

I am sure that once you are done with your calculations, a huge amount will be staring at you from your calculation sheet. Many of you who have endowment plans, moneyback plans, etc. as insurance covers, will even fear asking about the premiums for such large covers.

But don’t worry. Solution is there. And it is to buy plain term insurance cover. Its cheap and can provide coverage of almost Rs 1 crore for around Rs 10,000 – Rs 12,000. But remember one thing – term insurance has no survival benefits. You won’t get any money in case you don’t die within the insured period.

 

Important points:

  • Buying a term insurance does not mean that you don’t need to save for your future goals(retirement, kids education). It is only a backup plan in case you don’t survive that long. Insurance is not investment.
  • You are smart enough to purchase the right insurance cover for your family. But are your family members smart enough to deploy the huge insurance amount correctly (which they get when you die)? Don’t bet on it. Make sure that you sit with them and educate them what insurance is. And more importantly, what to do when they get the big amount. Tell them where to put the money and when to withdraw it. One wrong decision on their part and they will lose the money (a part or whole, who knows). And worst is that this is inspite of you having taken care of everything. So make sure you educate them.

There is a way to reduce your insurance requirements. Suppose you want to provide for your family’s expenses for 25 years (Part 2 of the above discussion). But your child’s education goal is just 10 years away (Part 3). So if you follow the approach discussed in article above, it will mean that you are paying for providing risk cover for the child’s education goal, even after its completion (i.e. 25 – 10 years = 15 years).

Effectively, you might find yourself paying a premium for sum assured that is higher than what is actually required. But that is not completely wrong. As I said, being over-insured is any day better than being under-insured. In any case, your insurance requirements keep changing every year.

The problem (though wrong to call it that), is solvable through an approach known as laddering of insurances. Its an approach where one buys term insurance plans of different durations that correspond to major goals like kids education, marriage, etc. Once the period of shorter-term plan is over, it frees up cash that can be invested elsewhere. Its an interesting topic – Laddering. I will write about it in another post soon.

What Would Happen If You took a loan of Rs 5 Lacs and Invested in Nifty?

Caution: Don’t do it without giving it a serious thought and knowing all the risks. For common investors, it is one of the riskiest things which they can do in stock markets.

Loan Invest Stock Markets



Common investors are better off avoiding mistakes than looking for multibaggers. Avoiding mistakes means not doing anything stupid with their money. It means having reasonable expectations and behaving reasonably. I will give you an example of each.
Example of Unreasonable Behavior
If a person has no idea about the actual business behind a share he has just purchased, then that is unreasonable behavior. The person is playing blind. He might still end up making money. But that is not because of his skill or any other ability, but because of his good luck.
Example of Unreasonable Behavior
Now markets can give returns in excess of 50% in a year. Compare this with returns of 8.5% given by traditional products and you would want to immediately dump your FDs, PFs, NSCs, etc. But expecting 50% to happen, year after year for decades, is a case of having unreasonable expectations. Such expectations, and actions based on those expectations are bound to cause serious losses in stock markets.
The problem with common investors is that they neither have the time nor the energy to sit and understand businesses behind the stocks they own. So ideally, the best way for them to avoid mistakes is to stick with investing in mutual funds.
But lets be honest.
Direct stock investing is glamorous.
And at times, it gives the perception that making money is easy – where else can you make 10% or more in a day. But this perception is just a perception and not the truth.
It is not easy to get above average returns in stock markets. I know most of you won’t believe me. But you need to take my word for it. It is easy to be average in markets. Just buy index (funds). But being better-than-average is difficult. And being better-than-average for long periods of time, is exponentially difficult.
Now lets come back to the topic…
The title of this post puts up a question, which can be linked to the behavior of someone who I personally think will be an Ultra Aggressive Investor. It can be looked at as one extreme end of a hypothetical risk spectrum depicted below:
Investor Personality
Think about it again. The title of this post asks you about what would happen if you took a loan and invested in something as risky as the stock markets. Sounds crazy. Isn’t it? And in most cases, it is crazy. In past, I have been regularly advising readers not to take loans to invest in stock markets.
But crazy might not be the right word to use here. It is actually all about the individual investor’s risk tolerance. To put it simply, it might be beyond the risk tolerance of a majority of people to invest in markets using borrowed money. Me included. But for many other, the risk may in fact be tolerable. I will come back to this discussion of risk in latter part of this post.
For now, I will tell you why this thought of doing a post on this topics came to my mind.
Few days back, I received a call from my credit card company, offering me a pre-approved personal loan of Rs 5 lacs at 10% for 5 years. I am sure many of you would be regularly getting similar unwanted calls. I politely refused the caller and told him that I didn’t need one. He tried convincing me but I managed to convince him against convincing me. 🙂
But today, I thought about it. What if I took this easily available credit (ofcourse at a cost – though not very high) and put it to better use?
In real life, I believe that there is no better use of money than to spend it on buying experiences that my family and I will remember for the rest of our lives. But the second best use that I could think off was to deploy funds in stock markets. But that is risky and against my personal philosophy of not using borrowed funds to invest, that too in an asset class which can give sleepless nights to many of us.
I also remembered a reader Krish’s comment on my post last year, that it was surprising that whole financial fraternity advocates equity investing with savings but not using borrowed funds. People about debt/equity ratios of companies, loans for start-ups but discourage if someone wants to invest in markets with loan.

Now my stand is still the same. I don’t intend to borrow and invest for sometime to come. Atleast not in next few years unless something like a PE10 event happens. 🙂
But the phone call from the credit card company and Krish’s comment had me thinking.
What – If ?
So instead of just thinking that investing using borrowed funds is wrong, I decided to see how this concept would have worked in past.
In rest of this post, what I will try to do is to use the past data to see what would have happened, if someone decided to invest Rs 5 Lacs in markets (after taking a loan). And to keep it simple, I will just stick with a scenario, where investment is made in the index. No direct stocks, futures or options. Just plain and simple index investments.
Sticking with the index is the easiest thing for a common investor. It might not be as profitable as active investing, but it still eliminates the risk of getting your stock picks or your fund picks wrong. By investing in index, one is not trying to beat the averages. One is trying to be the average. And that is not bad considering that averages in past have been in excess of 12% per year.
Now I am not sure what exactly was the interest rate or EMI, which the caller told me. But I used a simple loan amortization schedule to arrive at the required figures.
A loan of Rs 5 lacs at 10% for 5 years, can be serviced by an EMI of Rs 10,624.
This would mean that the borrower ends up paying Rs 6.37 lacs over a period of 5 years on this loan of Rs 5 lacs.
For the analysis, I got hold of Nifty data since 01-January-1999.
Now for each day, I assumed that an investment of Rs 5 lac is made in the Nifty. As already mentioned, this Rs 5 lac is funded by a loan for 5 years.
Then I calculated the returns on this investment after 5 years.
Now for analysis, ignoring other details like transaction costs, real value of money, mental stress, sleepless nights, etc., a return in excess of Rs 6.37 lacs for an investment of Rs 5 lac in index would mean that break-even point has been reached.
Anything above Rs 6.37 lac means that the entire transaction (Taking Loan –> Investing –> Repaying Loan –> Selling Investments) will be in green.
Again for simplicity, I am ignoring the debate whether it makes sense to take a loan just to break even after 5 years of risk-taking or not.
So here is the result set of more than 2900 data points:

15 Years Nifty Invesments

The blue line depicts the value of investments (of Rs 5 lacs) after 5 years.
The red line depicts the actual loan repayment amount which includes principal repayment as well as interest payments = Rs 6.37 lacs.
Now surprisingly, the blue graph hovers above the red line for most of the last 10-15 years! And at times, it even crosses Rs 30 lac! Yes… on an investment of just Rs 5 lac!
In fact, it’s below Rs 6.37 lac threshold for only 15% of the time.
Value of 5 Lacs 5 Years
Once again, this result points at the benefits of risky behaviour in stock markets. But it does nothing to show the risks involved. You might think that this behaviour is normal for stock markets. But that is not correct. India witnessed one of the greatest bull markets ever (in short term) between 2003 and 2007. The returns were so spectacular, that one cannot consider them to be normal. Its best to moderate the returns during the 2003-2007 Bull run to see a more realistic picture.
Now don’t draw any conclusions here. I am sure many of you would be having thoughts similar to the one below:
“That’s interesting. Even if I take a loan of say Rs 5 lacs, I only end up paying about Rs 10,000 a month as EMI. In return what I get is a chance to increase my investment from Rs 5 lacs to upto Rs 30 lacs!! Doesn’t that sound great? Also the chances of things going totally wrong are just 15%. Can’t I take this bet? Not much to loose here.”
Now I will tell you a real life fact here. If you take a loan, you would be using your available credit limit. And it’s also possible that you might not be able to avail any other personal loan till you clear off this existing loan. Now what will you do if you need that money for some emergency? You don’t want to sell your investments and exit at a price, which might be not acceptable to you. What if that emergency is such that you need to sell out irrespective of your losses. It’s not that easy. I hope you can realize the gravity of such a situation.
Now lets do one thing. Lets evaluate these returns, on the basis of P/E multiples of the Nifty. I have done some detailed analysis of PE in past. You can check it here.
In below graph, I am just breaking down the numbers obtained for Rs 5 lac investment on basis of Nifty P/E data.
Value of Nifty PE 5 Years
I am sure you would have observed a trend here. Lets focus on the first column:
PE 12 India Stocks
The very first thing to notice here is that a market below PE12 is extremely rare in Indian context. In the analysis, there were just 58 instances out of 2900+, where this actually happened. That is just about 2%. So if you want to time the markets and then take a loan, then please remember that it’s tough.
Also a real life fact is that when markets are available at levels where PE is close to or below 12, it would mean that economy is in doldrums. This would mean that credit would not be available easily. So you won’t get any cheap and easy loans to invest in PE12 markets. This is a very important point to remember.
But lets suppose that you do find money to invest. Now the chances of turning profitable (investment value more than Rs 6.37 lac) are much higher at lower PEs than they would be in say during high PE zones of 20+ (below):
PE 20+ India Stocks
As you can see above, most of the instances in encircled box are towards the top, i.e. lower returns on investment of Rs 5 lacs (which eventually costs Rs 6.37 lacs).
So if you find that PEs have gone down to horribly low levels (CRISIS) and if you can tolerate the risk (COURAGE). and can borrow quickly from any family source at say 0% (CASH), then that will be great. Congratulations of combining the 3 Cs. That is the formula of getting rich in stock markets.
Now I have told you that personally, I don’t intend to take such a risk. But I know people who have done this successfully. A good friend of mine is one of the most aggressive investors I have ever known. He did what I can never do. He borrowed about Rs 25 lacs from various sources like banks, family, and friends and invested in around 10 stocks in 2013. Now his portfolio value exceeds Rs 50 lacs and he is still paying regular EMIs. I am trying to convince him to prepay atleast a part of the big loan with his profits. But he is a perennial optimist. I just hope it works for him in the long run. 🙂
Let me now add a few concluding words about the risk-discussion I parked in the first half of the post.
Is it a good idea to borrow money to invest in stock markets, which are inherently risky?
Honestly speaking, there is no definitive answer to this question. I am biased by my own behaviour to say that it’s wrong to do. But data (above) shows that there may be some merit in it if the cost of borrowing the funds is not much.
Like all other investment choices, this choice is also linked primarily to an investor’s investment risk tolerance and has multiple dimensions of risk: the risk of taking loans and the risk of investing in the stock market.
The biggest risk with loans is that it’s a promise to pay back in future, which is based on the assumption that you will continue to earn enough to regularly service the EMIs. But future might bring in some unfortunate incidents that your ability to repay loans may be compromised. This makes loans risky.
Then there is the general risk associated with stock markets. Data analysis I did is fine. But past performance is never a guarantee of future returns. 🙂
Now when we combine these two risks, things can get really complex and unthinkable.
Just a situation for you to ponder about. You take a loan to invest. You end up investing when markets were not cheap. Markets crash. Your investments are down 30%. Economy itself turns bad. You are fired from your job. But you still need to pay EMIs and run your house. You end up selling your investments at a loss. Your entire data driven plan goes out of the window.
But on the upside, things can be beautiful – as shown in a data point to where an investment of Rs 5 lacs turned into something above Rs 30 lacs in just 5 years!
To put it very simply, the idea of borrowing to invest itself is not bad. It is just a very risky one. More so if you are a common investor under common circumstances.

A Cheatsheet for Automatically accumulating Funds for Future Repeat Purchases

Note – This is a guest post by Ajay. He has already written quite a few thought-provoking articles like wealth accumulation through SIP, lumpsum investing in mutual funds. Sometime back, I collaborated with Ajay for doing a detailed comparative analysis about investing in Real Estate Vs. Mutual Funds. The post was well received and became widely shared over the social media.

So over to Ajay for another interesting analysis…

In last 15 – 20 years, our lifestyles have changed dramatically. I am sure that even 10 years back, no one would have imagined that our lives would become slaves to gadgets like mobiles phones, iPads, etc.

Whether this lifestyle is correct or not is a question best left for another day.

For a person who belongs to the previous generation and typical middle class family, important life goals were pretty well known:

  • Complete your education
  • Get a decent job (preferably government job)
  • Have a regular monthly salary
  • Live a contented life within the limited salary
  • Bring up your kids nicely
  • Before retirement, get yourself a house
  • And live a retired life dependent either on your pension or on your kids

Plain and simple. Any deviation from this, and you could easily be termed as being the odd one out. 🙂

Now during those good old days, the concept of credit cards, EMIs, Zero down-payments was not there at all. And that was because when we compare those times with current one, the desires and requirements of previous generation were very limited.

For a moment, imagine your life without the following:

  • Smart Phones
  • Computers / Laptops
  • Tablets
  • Smart LED TVs
  • Music Systems
  • Air Conditioners
  • Refrigerators
  • Kitchen Equipments
  • Home furnishing
  • Two Wheelers
  • Four Wheelers
  • Multiple Four Wheelers 🙂

I know. Its tough to even think about a life without these. Life would be so difficult. Isn’t it?

Some of the these products have long lives and don’t need to be replaced frequently. But for others, regular replacement is advised (atleast by the manufacturers). For example, you might want to upgrade your smart phone every 3 years. On the other hand your desktop PC might need a replacement after about 7 years. Same for television and refrigerator.

Another reality is that once we get used to the comfort and convenience provided by these gadgets and their subsequent upgrades, it is not easy to simply go for a product that offers reduced comfort or features. And even if you do decide to do it, you might not feel very comfortable about it socially. For example, if you have been an iPhone or iPad user, it is highly unlikely that you will start using a basic smart phone.

Just to deviate a little, this shows the strength of the moat that Apple has been able to create over the years. The high social and emotional cost of switching to competitor products. And this indeed is the real reason that Apple is trading at a Market Cap of more than $700 Billion. You might like reading an article where Dev evaluates the biggest company of India and how small it actually is when compared to Global biggies.

Now here comes the important part.

Money For Future Repeat Purchases

If one observes carefully, it can be deduced that the prices of these products generally reduce over their lifetimes. But due to technological advancements, newly launched products offer additional comforts and features. And therefore, one is keener to buy an upgraded and superior product – which ofcourse comes at a higher price.

Now lets be honest…

We will always buy improved and upgraded products even though it might cost us more. Isn’t it? Under normal circumstances, our aspirations and needs are ever-increasing.

These days, the trend is too simply go and buy whatever you want.

How to pay for it? Use your credit card. Find it tough to pay your credit card bill? No worries. Convert it into EMI.

That’s it. Life is easy.

Credit is easily available for even very small purchases. And what is the justification for these increased credit-funded purchases? One is instantly able enjoy the benefits of product, without waiting for years. It is another matter that significant amounts are paid as interests, processing fees and insurance charges, even before you start using the product. Not to mention the continuous mental pressure of making the payment on time.

But if you are young, then you might not have many responsibilities and buying the product on credit may still not be a very big issue for you.

However when you have to repeat your purchases in future, say after 10-15 years, you would have additional responsibilities like higher family expenses, child education, medical expenses and so on. At that time, you might not be in a position to forego that comfort and may even have to pay much more to buy a superior product.

The question then is that how should one fund these repeated product purchases, without straining the regular cash flows?

I take television as an example for this study. This product is a perfect fit for the category that has undergone numerous technological advances.

So while the price of the old product has come down significantly (and some have become obsolete), there are other superior products available at much higher prices.

Also it is a kind of product you tend to replace after quite a long time, say 10 to 15 years (I used my last CRT TV for 15 years without any trouble before switching to a larger Smart LED TV).

In 1999, the cost of a 21-inch CRT television was approximately Rs 20,000.

In comparison, a full HD Smart 32-inch LED television costs Rs 44,000 today (in 2015).

As for the old tech 21-inch CRT television, it is still available at some places at a price as low as Rs 8500. But I am pretty sure that almost everyone these days will prefer buying a LED or LCD television and not the CRT one.

Now if given a choice, everyone would prefer to live a debt free life. But that is only possible if either you have loads of money; or if you can meticulously plan for most of your purchases in advance.

In my opinion, one should opt for loans and EMI only for buying the first house for self-occupancy – which also provides tax benefits. All other items bought for comfortable living and luxury, should be funded through savings and investments through proper planning.

In this case study of television, I have assume its useful life to be about 15 years. Lets see how we can fund the repeat purchase after 15 years.

Cost of CRT television in 1999 – Rs 20,000

Cost of LED Television in 2015 – Rs 44,000

Now here is the hypothesis. After buying the television in 1999, if a small percentage of the initial purchase value is invested in an investment option, whose ideal maturity period, matches that of the remaining time left for the repeat purchase, then it will automatically fund the future repeat purchase.

Sounds lovely? Automatically funding your repeat purchase? Read on…

Let’s say that 10% of the TV purchase amount (i.e. Rs 2000) was allocated for future repeat purchase. And this was invested in a financial product, which matched the expected duration of the repeat purchase.

In this case, the repeat purchase is expected after 15 years. Let’s see whether the purchase could have been funded automatically by this investment or not?

Since the investment duration is 15 years, the obvious choice of investment option is Equity Mutual Fund.

Let’s analyze by investing 10% amount (Rs.2000) in Franklin Prima Plus Fund on 01-Jan-1998. Rs 2000 Invested on that date, would have grown to Rs. 88,608 and would have easily funded your repeat purchases for not one but two televisions.

Lets pick another fund…

If Rs 2000 had been invested in Reliance Growth Fund, it would have grown to Rs 119,220 –good enough to fund almost 3 such televisions.

But for sake of being unbiased, lets choose another fund. And this time, lets pick up a fund that is not known to be a great one.

Lets take the worst performing fund of last 5 years in its category.

So now if the amount of Rs 2000 been invested in Sundaram Growth Fund, it would have grown to Rs 31,142. Agreed that it would not be good enough to fund a new 32-inch LED Smart TV. But it would still have been sufficient to buy a 32-inch regular LCD TV.

The point that I am trying to make here is that, by investing even a very small % of the actual amount spent on the initial purchase, you can more or less fund the repeat purchase of the item in future. And that too very easily.

For a moment lets assume that you are not able to contribute this 10% (for future repeat purchase fund) at the time of initial purchase.

No problem at all.

Divide the amount (Rs 2000) by 12 (~ Rs 200) and start a SIP for the divided amount for next 12 months.

Contributing Rs 200 monthly would not have been a problem for someone who is spending Rs 22,000 for buying a TV in 1998-99. Even this approach of breaking the amount into a small SIP would have yielded almost the same result.

Lets come back to 2015 now…

Now even today, if you are buying a LED TV for Rs 44,000, then contributing a small amount of Rs 600 per month for next 12 months should not be a very big issue.

But what if you don’t want to wait for 15 years to change your TV?

Suppose you want to change it every 7 to 10 years.

Even then, the suggestion would be to go for equity mutual funds. But since the expected duration is less (i.e. the time remaining in the next repeat purchase), your percentage contribution of the initial purchase value needs to be increased to say 20% to 25% as per the duration.

Lets take another example…

In year 2005, the cost of Honda Activa was Rs 44,000. And in 2015, the cost of same vehicle is Rs 58,000 approximately.

Now if one had invested Rs 16,000/- (in a fund for repeat purchase) in a diversified equity mutual fund in 2005, the money would have sufficiently grown to fully fund your new vehicle in 2015. And just to share some numbers, Rs 16,000 invested in Sundaram Growth Fund in July-2005 is now worth Rs 58,300. The same amount invested in Franklin Prima Plus Fund is now Rs 1,19,539.

Its quite understandable that as when you buy a vehicle for Rs 44,000, it is very quite tough find additional Rs 16,000 for something, which is to be bought 10 years later. But even if you cannot afford a one time investment, you can again divide this amount into small parts and do a SIP of 1 or 2 years.

But it is also possible that you don’t want to wait for 10 years. You want to buy another similar vehicle in 5 to 7 years. If that is the case, then it’s recommended to go for Recurring Deposits.

As a conclusion to this already long post, I would say that in order to maintain or improve one’s life style, one has to make some provisions for future. Proper, sensible planning….combined with investing a portion (10% to 20%) of the initial purchase value, will go a long way in giving you the financial comfort and also help you avoid getting trapped in loan-EMI cycle. In addition, it will not strain your regular cash flows during your middle ages, when there are other expenses that take precedence over these lifestyle related expenses.

Do let us know how you make provisions to fund future repeat purchases of necessary items.

Life @ 13.99%

Many people take loans for various reasons. Some take it  for unavoidable reasons and others for avoidable ones…or for ones which can be easily delayed, like vacations, purchase of electronics, luxury watches, etc.

But before you read further, I would request you to understand that I am not against those who take loans. Everyone’s needs and situations are different. Even I have taken loans in past.

Since last few days, the following image is popping up on the website of a large private bank whose services I use to conduct my financial transactions.
Personal Loan - Vacation
As you can see, the bank is telling you few important things…

First is that ‘Life is waiting’. And that is a fact. Nobody can be wrong by making such a statement. There are so many things to do in life that sometimes I feel one life isn’t enough to fully experience life. 🙂

Now second thing to observe is that the image above shows a couple enjoying vacation in Europe (probably). Now a decent European vacation for two costs around Rs 4 Lacs. This picture pops up just before one logs into bank’s website. Therefore, my assumption is that bank is showing this image to everyone irrespective of whether person logging into bank’s website is or isn’t a suitable candidate to pitch such visual advertising to sell loans for luxurious expenditures. 

It means that bank does not take into account customer’s past average balance, repayment histories before making the (very first) pitch for the personal loan.

Once again, I am not saying that one should not take loans. But vacation is something which can be delayed. Or should be planned well for. Vacations are generally not spur-of-the-moment decisions.

So it is better to plan for them from the very day the final decision is taken. Isn’t it? And some people actually don’t want to take loans for such discretionary spendings. They plan well and well before the day funds are actually required. Just sometime back, I received a mail from a reader to help him plan his funding of a trip to Dubai he wanted to gift to his wife.

For the time being, lets not judge whether what bank is doing is correct or not. Bank can anyways justify its marketing actions by saying that there are proper processes in place for approving loans to check suitability of candidate.

And they are right in saying this. They can also give an example that there are no checks on who sees the hoardings on sides of highways offering home loans for budget(!) homes costing 1+Crore. Once again they are not wrong.

This brings us to a possible conclusion that onus and responsibility of applying for loans of any kind lies with customer and not with bank. 

Bank only evaluates suitability of the applicant and then decides to lend or not to lend to him / her. Bank is there to lend you money for all your expenses. But it is for you to decide whether you need to take a loan for something which is as discretionary as a vacation, or something which has the potential to generate future wealth like property or commercial vehicles. 

Always have limits to how much you will borrow and for what reasons you are willing to borrow. Because eventually, this will be a major determinant of whether you will be rich or not.

By the way, I feel that banks are generally ready to give loans to those who don’t need it. What do you think? Also, if you have any stories about your loan related experiences which you think will be beneficial for others, please feel free to share the same in comments or drop me a mail at stableinvestor@gmail.com

Mailbag: I have a loan. Should I Pay It Off Before Investing?

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.

Mailbag Readers Question Answered

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…
Debt 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).

Please note that by using the word ‘BAD’, I do not mean the bad loans which are a major concern for PSU banks.

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

Pay Off Loan Or Invest & Save
The Decision

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).
  • Get rid of them as soon as possible.
  • Now pay off loans taken to buy liabilities (cars, gadgets) which do not produce a stream of cash.
  • Initiate creation of an Emergency Fund which takes care of unforeseen money requirements.
  • 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.

Anyways.. I hope that above information helps Shivangi in her efforts to pay off loan and simultaneously create a stable investment portfolio.

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WTF… Wrist Watch On EMI??

Either I am getting old or there is something seriously wrong with the way our generation has decided to manage their finances. Just last night, I was taking a stroll with my wife in South Mumbai when I saw a board outside a shop –

Wrist watches on EMI
A Ticking (Financial) Bomb On Your Wrist

This shop was selling wrist watches of some good medium-to-high-end brands. And it provided the customer an option of purchasing these wrist watches on EMIs!!
Now I am not saying that this is wrong. But seriously, isn’t it simple common sense to use loans to buy assets rather than wrist watches??

I am sorry that this post is short and a little aggressive. But I could not stop myself from sharing my agony at seeing such a financial crime being committed by young people. I don’t say that one should not indulge in buying what one likes. But there are other ways of buying a watch. Instead of taking a loan and paying EMIs, one can delay the purchase a few months and save money in a Recurring Deposit(or even a simple savings account) and then buy the product. Its that simple.

And this wrist watch thing was not just one-off case. My wife told me that now-a-days, even lady’s handbags are available on EMIs!!!!


I have nothing more to say. Period.

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