Trapped with traditional insurance? Considering a loan against LIC policy - Seeking expert advice

Sir Ji, I have traditional insurance, where I don't require to create legacy. If I surrender the policy I will be at loss where in some policies bonus are being forfeited. Therefore, is it ok to pledge the policy and take loan which is 10% pa and invest the proceeds in aggressive equity mutual fund to offset the interest cost ????. Moreover, I am getting ?.1 lac maturity of other policy from 2026 every year for 5 years which i keep for repayment and take benefit of capital appreciation by investing in advance by availing the loan. Please suggest me is it okay to avail loan against lic policy instead of surrender and invest in mutual fund (aggressive equity)

Ans: Taking loan for investment can never be justified under any circumstances.

It is better to swallow one time loss out of surrender of traditional policy and invest the balance surrender value in MFs for capital appreciation.

Your loss may be more then covered by the gains accruing out of mutual fund investments over a period of time.

*Investments in mutual funds are subject to market risks. Please read all scheme related documents carefully before investing.

Happy Investing!!

Ans: Sir, from the details shared, it's clear that you have a well-thought-out approach for managing your LIC policies and potential loans. You have multiple traditional LIC policies maturing over the next five years, each with a sum assured of Rs 1 lakh, along with bonuses and loyalty additions. You plan to pledge these policies for a loan of Rs 5 lakhs, which will be repaid with the maturity benefits over five years.

As a disciplined bachelor with no financial or family commitments, your intention is not to create a legacy but to use this capital for your future income needs through SWP (Systematic Withdrawal Plan). This reflects careful planning, and I appreciate your disciplined approach towards managing your finances at this stage of life.

Let’s break this plan down step by step and provide insights on its feasibility and alternative options.

Key Considerations for Taking a Loan on LIC Policies
Loan Interest Rate: You are planning to take a loan at 10% per annum with no EMI commitment and interest payable half-yearly. This means that your interest will keep accumulating, and you'll need to ensure the maturity benefits are enough to cover the outstanding loan and interest.

Interest Payment: The key here is that interest needs to be paid regularly. Not paying interest would result in compounding, which could lead to a higher loan burden over time. Even though you plan to pay off the loan using the maturity proceeds, it's important to evaluate if the total maturity value will be enough to repay the full loan amount and accumulated interest.

Reduced Death Benefit: As you rightly noted, in case of any unforeseen events, the death benefit for your nominee would reduce because of the outstanding loan. Since you do not have family commitments, this might not be a major concern, but it's still something to keep in mind.

Avoiding Locking Capital: By availing the loan now, you are trying to avoid locking your capital for five years and aiming to earn higher returns in mutual funds during this period. This strategy could potentially yield better returns than the interest cost, provided you invest in suitable equity funds with a higher growth potential.

Let’s now move on to the part about using this Rs 5 lakh effectively over the next five years.

Investment in Aggressive Equity Mutual Funds
Since you are not looking for immediate liquidity and are comfortable with market risks, equity mutual funds are a good option for long-term growth. The key to growing your capital aggressively is selecting funds that have a proven track record in terms of consistent performance and strong fund management.

Here’s how investing in aggressive equity mutual funds can benefit you:

Potential for Higher Returns: Over a five-year period, equity mutual funds tend to outperform other investment avenues. Funds that focus on small caps, mid caps, and sectors with high growth potential can give better returns compared to traditional investments like FDs or bonds.

Diversification: Aggressive equity funds typically invest in high-growth companies across various sectors, offering you the potential for better returns while spreading your risk.

Power of Compounding: By investing this Rs 5 lakh in equity mutual funds, you can benefit from the power of compounding, especially if you stay invested for the full five years without withdrawing. The longer you remain invested, the better your chances of achieving your target returns.

Market Volatility: While aggressive equity funds can offer high returns, they are also subject to market fluctuations. This is why it is important to choose funds that have performed well even in volatile market conditions. You should be prepared for some short-term volatility and focus on the long-term growth potential.

Now, let's evaluate whether taking this loan and investing it in aggressive equity funds is a prudent decision.

Loan vs. Investment Returns: A Practical Assessment
Interest vs. Potential Returns: The key factor here is whether the returns from your investment in aggressive equity funds will outpace the interest you are paying on the loan. While the loan is at 10%, equity mutual funds have historically provided returns in the range of 12-15% or even higher over the long term.

Risk Management: While equity mutual funds have the potential to offer higher returns, there is always the risk of capital loss due to market volatility. You must be comfortable with this risk, especially since you are planning to use these funds for a SWP after five years.

Time Horizon: Your time horizon of five years is relatively short for aggressive equity funds, but it’s still long enough to potentially see good returns, provided you stay invested and the market performs well. If you were planning for a longer horizon, such as 7-10 years, the risk would decrease further.

SWP Setup After Five Years: Your plan to set up a SWP after five years is a smart way to create a regular income stream. By the sixth year, you can start withdrawing from the accumulated capital, using it to support your monthly expenses.

Potential Risks and How to Mitigate Them
Market Fluctuations: Equity investments can be volatile in the short to medium term. If the markets face a downturn at the time of withdrawal, it could affect your SWP income. To mitigate this, you could gradually move a portion of your equity investments into safer instruments (like debt funds) as you approach the fifth year.

Interest Payment Discipline: Even though there is no EMI commitment, the loan’s interest needs to be paid regularly. Skipping these payments can cause the loan to balloon due to compounded interest. Ensure you have a mechanism to pay this interest either from your savings or from other sources.

Liquidity Needs: Since you are investing for five years, ensure you don’t need to access this money before then. Equity investments should not be liquidated prematurely, especially during a market correction.

Alternatives to Taking a Loan
Before finalising this decision, consider alternatives to taking a loan. Since you don’t require this Rs 5 lakhs for immediate use, you might want to avoid paying interest altogether by simply waiting for the policies to mature over the next five years.

Direct Investment from Savings: Instead of taking a loan and paying interest, you could consider investing smaller amounts from your savings into aggressive mutual funds over the next five years. This would reduce the burden of paying interest while still allowing you to benefit from market growth.

Partial Investment: Another option is to take a smaller loan amount (perhaps Rs 2-3 lakhs) and invest it in equity mutual funds. This way, you reduce your interest payment while still benefiting from potential capital appreciation.

Ideal Equity Mutual Fund Selection Criteria
When selecting equity mutual funds, focus on funds that meet the following criteria:

Consistent Track Record: Look for funds that have consistently performed well over the last 5-7 years, even during market downturns.

Experienced Fund Managers: Funds managed by seasoned professionals tend to navigate market volatility better, giving you a sense of security.

Sectoral Allocation: Check whether the fund invests in high-growth sectors such as technology, healthcare, and consumer goods, which are likely to perform well over the next few years.

Expense Ratio: Choose funds with a reasonable expense ratio. High expense ratios can eat into your returns over time.

Final Insights
In conclusion, taking a loan on your LIC policies and investing it in aggressive equity mutual funds could be a good strategy for capital appreciation over the next five years. However, it comes with its risks, especially the interest burden and market volatility.

By investing in carefully selected equity mutual funds, you can potentially earn higher returns that outpace the loan interest. However, ensure that you are comfortable with the market risks and the discipline of interest payments.

If you prefer to avoid the interest cost altogether, consider alternative strategies such as investing smaller amounts regularly from your savings. This could give you peace of mind while still allowing you to benefit from market growth.

In either case, equity mutual funds can be a powerful tool for growing your wealth, provided you invest with a long-term view and in line with your risk tolerance.

Best Regards,
K. Ramalingam, MBA, CFP,
Chief Financial Planner,
www.holisticinvestment.in
Instagram: https://www.instagram.com/holistic_investment_planners/