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Should I take a loan of ₹5,00,000 against my Motilal Oswal Small Cap Fund and reinvest it?

Ramalingam

Ramalingam Kalirajan  |8104 Answers  |Ask -

Mutual Funds, Financial Planning Expert - Answered on Mar 15, 2025

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 - Mar 15, 2025Hindi
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I AM THINKING OF TAKING A LOAN OF 5,00,000 AGAINST MY CURRENT MUTUAL FUND MOTILAL OSWAL SMALL CAP FUND AND REINVEST IT IN SAME FUND FOR NEXT 3 YEARS. I DON'T WANT LIQUIDITY FOR NEXT 3-4 YEARS. SEEING THE MARKET IS LOW RIGHT NOW CAN I EXPECT A REURN? SHOULD I CONSIDER THIS OPTION?

Ans: Taking a loan against your mutual funds and reinvesting in the same fund may seem like an opportunity to maximise gains. However, this strategy carries significant risks.

Key Risks to Consider
1. Market Uncertainty
Small-cap funds are highly volatile.
A temporary market correction doesn’t guarantee strong returns in the next 3 years.
If the fund underperforms, you could face both a loan repayment burden and lower returns.
2. Interest Cost vs. Expected Returns
Loan interest rates on mutual fund pledges typically range from 9-12% per annum.
Your small-cap fund must generate higher returns than the loan rate to make this strategy profitable.
If the fund returns below 12% CAGR, your effective gains will be negligible or negative.
3. Forced Liquidation Risk
If the market corrects further, your lender may sell your pledged mutual fund units to recover the loan.
This could happen at a loss, forcing you to exit at a lower NAV.
4. Overexposure to a Single Fund
Investing additional money into the same small-cap fund increases concentration risk.
Instead, diversification across flexi-cap, mid-cap, and small-cap funds is better.
Alternative Approaches
Instead of taking a loan, consider:

SIP Investment Strategy

Continue SIPs in a staggered manner rather than a lump-sum reinvestment.
This reduces the risk of investing at an unfavourable price.
Diversified Portfolio Allocation

If markets recover, large-caps and flexi-caps may rebound earlier than small-caps.
Diversifying into these categories will balance returns and risk.
Rebalancing Your Current Portfolio

If you have underperforming funds, consider shifting money to stronger funds.
This avoids borrowing costs and interest rate risks.
Final Insights
Taking a loan against your mutual fund for reinvestment is not advisable due to the high risk of market downturns, interest costs, and forced liquidation. Instead, a disciplined SIP approach in diversified funds will offer better risk-adjusted returns.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in
https://www.youtube.com/@HolisticInvestment
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.
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Ramalingam

Ramalingam Kalirajan  |8104 Answers  |Ask -

Mutual Funds, Financial Planning Expert - Answered on Dec 16, 2024

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Hello Ramalingam sir, In below communication, i see advice from one guru that investment from loan is not suggested under any circumstances, but i didn't understand good resoan behind. If i consider n compare investment made in MF (say HDFC mid Cap opportunity growth fund for instance) 5 yrs back from now vs interest on loan (say 10%) i see after equations (profit reinvestment/ compounding) n even after LTCG Tax deduction every year, i still would be drawing a good capital. Isnt it? Am i making any wrong calculation. Plz advice with figures.
Ans: Investing with borrowed money may seem profitable when comparing past mutual fund returns to loan interest rates. However, several factors make this strategy risky and generally unsuitable for most investors. Let’s break it down analytically.

Understanding the Appeal of Investing with Loaned Money
The logic behind the appeal is simple:

Borrow money at 10% interest.
Invest in a mutual fund delivering returns greater than 10%.
Use compounding to generate a profit.
For example, if the HDFC Mid Cap Opportunities Growth Fund delivered 18% annualised returns over the last 5 years, it seems to outperform the 10% loan interest rate, even after taxes.

But the calculation oversimplifies several critical aspects.

Why Investing with Borrowed Money Is Risky
1. Market Volatility Risks
Mutual fund returns fluctuate.
Past performance is not a guarantee of future returns.
A market downturn could cause your portfolio to underperform, leaving you with a loan to repay regardless of the market.
Example
If markets crash, the fund may return -10% in a year.
Your capital decreases, but loan EMIs remain fixed.
2. Guaranteed Loan Costs vs. Uncertain Returns
Loan interest is a fixed cost.
Investment returns are uncertain.
This mismatch increases the risk of financial loss.
Example with Figures
Loan Amount: Rs. 10 lakh at 10% annual interest.
Mutual Fund Return: 18% annualised over 5 years.
Loan Cost: Rs. 6.1 lakh in interest over 5 years (EMIs = Rs. 21,247/month).
If the market performs well:

Investment grows to Rs. 22.9 lakh (18% compounded over 5 years).
Profit after loan repayment: Rs. 6.8 lakh.
If the market underperforms (8% return instead of 18%):

Investment grows to Rs. 14.7 lakh.
Loan repayment leaves you with only Rs. 4.7 lakh, eroding your capital.
3. Stress on Cash Flow
Loan repayments (EMIs) are mandatory.
In emergencies or job loss, this can strain your cash flow.
4. Impact of Taxes
LTCG tax (12.5% beyond Rs. 1.25 lakh) and STCG tax (20%) reduce actual returns.
Loan interest has no tax benefit for investments.
Example of Tax Impact
Without taxes: Rs. 22.9 lakh after 5 years at 18%.
After LTCG tax: Rs. 21.4 lakh.
This reduces your profit further, diminishing the gap between returns and loan costs.

5. Risk of Leverage
Leverage amplifies both gains and losses.
In a worst-case scenario, you could lose your investment and still owe the loan.
Example of Loss
Rs. 10 lakh loan invested during a market downturn.
Portfolio falls 20% in Year 1 (value = Rs. 8 lakh).
You repay Rs. 21,247/month (total Rs. 2.55 lakh annually).
After 5 years, you could lose Rs. 4 lakh or more.
Comparing Scenarios: Borrowed vs. Own Money
Borrowing Money for Investment
Loan Amount: Rs. 10 lakh.
Returns: 18% compounded over 5 years.
Total Returns: Rs. 22.9 lakh.
Loan Repayment: Rs. 16.1 lakh (Principal + Interest).
Net Profit: Rs. 6.8 lakh.
Investing Own Money
Investment Amount: Rs. 10 lakh.
Returns: 18% compounded over 5 years.
Total Returns: Rs. 22.9 lakh.
No Loan Repayment: Entire profit remains yours.
The difference is clear: investing with your own money eliminates repayment stress, taxes, and risk.

Final Insights
Investing with borrowed money can backfire due to unpredictable markets and fixed loan costs.

Use your own funds for investments instead of leveraging loans.

Stay diversified and invest systematically for long-term wealth creation.

Best Regards,

K. Ramalingam, MBA, CFP,

Chief Financial Planner,

www.holisticinvestment.in
https://www.youtube.com/@HolisticInvestment

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DISCLAIMER: The content of this post by the expert is the personal view of the rediffGURU. Investment in securities market are subject to market risks. Read all the related document carefully before investing. The securities quoted are for illustration only and are not recommendatory. Users are advised to pursue the information provided by the rediffGURU only as a source of information and as a point of reference and to rely on their own judgement when making a decision. RediffGURUS is an intermediary as per India's Information Technology Act.

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