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Ramalingam Kalirajan |7204 Answers |Ask -Follow

Mutual Funds, Financial Planning Expert - Answered on Jun 25, 2024

Ramalingam Kalirajan has over 23 years of experience in mutual funds and financial planning.
He has an MBA in finance from the University of Madras and is a certified financial planner.
He is the director and chief financial planner at Holistic Investment, a Chennai-based firm that offers financial planning and wealth management advice.... more

Asked by Anonymous - Jun 18, 2024Hindi

Hello Guru, need advice if I can take personal loan of 15 lakhs and use 5 lakhs to purchase used car, rest money I will SWP in index fund or hybrid aggressive fund or half in bonds and half in swp. Continue till money last and than sell car, and close loan. Will this plan work?

Ans: Hi, thanks for sharing your plan. It’s crucial to analyze it thoroughly before proceeding. Borrowing money to buy a depreciating asset and investing the rest in mutual funds involves significant risks. Let’s break it down.

Borrowing for a Depreciating Asset
Purchasing a car with a loan requires careful consideration:

Depreciation: Cars lose value quickly. Buying a used car means it’s already depreciated, but it will continue to lose value.
Loan Costs: Personal loans come with interest rates. This increases the overall cost of the car.
Necessity: Evaluate if buying the car is essential. If it’s not absolutely necessary, it’s better to avoid this purchase.
Risks of Borrowing to Invest
Investing borrowed money in mutual funds or bonds is risky:

Market Volatility: Mutual funds, including index funds and hybrid aggressive funds, are subject to market fluctuations. You could lose money if the market performs poorly.
Interest Burden: The interest on the loan might outweigh the returns from investments, especially if the market underperforms.
Financial Stress: Managing loan repayments while hoping for investment returns can create financial stress.
Investing in Index Funds and Hybrid Aggressive Funds
Let’s discuss the potential pitfalls and considerations:

Index Funds: These track the market index. While they are low-cost, they still carry market risks. In a downturn, your investment value can drop significantly.
Hybrid Aggressive Funds: These have a mix of equity and debt, but the equity component can still be volatile. They aim for higher returns but come with higher risk.
Bonds: They provide stable returns but are usually lower than equities. Investing in bonds alone may not yield enough to cover loan interest and principal.
Systematic Withdrawal Plan (SWP)
Using SWP to generate regular income has pros and cons:

Regular Income: SWP can provide a steady income stream, which might help manage loan repayments.
Depletion Risk: The invested corpus can deplete faster than expected if the market performs poorly or withdrawals are high.
Taxes: SWP withdrawals are subject to capital gains tax, which can reduce net returns.
Dangers of Combining Borrowing and Investing
Here are key points to consider:

Double Risk: You’re taking on debt (a fixed obligation) while investing in market-linked instruments (variable returns). This creates a double risk.
Interest vs. Returns: Loan interest rates are usually fixed and can be high. Investment returns are not guaranteed and can be lower than the loan interest.
Liquidity Crunch: If the market performs poorly, you might struggle to repay the loan and meet other financial needs.
Recommended Approach
Here’s a safer and more balanced approach:

Avoid Loan for Car: If the car is not absolutely necessary, avoid taking a loan for it. Consider other transportation options or save up to buy a car without a loan.
Build Emergency Fund: Ensure you have a robust emergency fund before investing or taking on any debt.
Clear Existing Debts: If you have any existing debts, prioritize clearing them before taking on new ones.
Invest Wisely: Continue your existing investments in mutual funds, but do so with disposable income, not borrowed money.
Diversify Investments: Diversify your portfolio across different asset classes based on your risk tolerance and financial goals.
Alternatives to Consider
Use Savings for Car: If buying a car is necessary, use your savings rather than taking a loan. This avoids interest costs.
Increase Savings Rate: Boost your monthly savings and investments gradually to meet your goals without borrowing.
Goal-Based Planning: Align your investments with specific goals, ensuring a balanced approach to risk and return.
Final Insights
Borrowing to buy a depreciating asset like a car and investing the borrowed money in market-linked instruments is highly risky. The potential returns might not outweigh the interest costs and market volatility. It's better to avoid this approach unless the car purchase is absolutely necessary. Focus on building a strong financial foundation, clearing existing debts, and investing wisely with your savings. This approach will lead to a more secure financial future.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in

DISCLAIMER: The content of this post by the expert is the personal view of the rediffGURU. Users are advised to pursue the information provided by the rediffGURU only as a source of information to be as a point of reference and to rely on their own judgement when making a decision.