Your net take-home pay is Rs 1 lac. Your expenses range from 50-60K per month. You invest Rs 40,000 per month diligently. You have automated your investments through SIPs, recurring deposits and setting up auto-debit.
You want to purchase a laptop costing around 45,000. What are your options?
- Break/redeem your existing investments and pay for the purchase in full. Or you could initially use your credit card and pay the credit card bill in full by the next month. This could be from an emergency/contingency fund or any other portion of your portfolio. However, there could be exit penalties and tax impact.
- Pause your investments for a month, set off the credit card bill in full and restart.
- Take credit. And credit can take many forms.
- Credit card: The most expensive debt. If you do not pay in full, we have a problem.
- No-cost EMIs
- Personal loan EMIs
- Overdraft
- Buy now, pay later
Except for credit cards (with partial payments), there is no right or wrong approach. I can see merits in all other approaches.
The options discussed in Approach (3) will have additional cost in the form of interest. There may be ancillary costs such as processing fees too. However, you need to weigh this cost against disturbing your investments on autopilot (Approach 2). And weigh against exit penalties for redeeming your investments and the associated tax impact (Approach 1).
Approach 1 (Redeem Investments) vs Approach 3 (Credit)
Sometimes, even a spreadsheet analysis may suggest that you go with Approach 3 instead of Approach 1. Counter-intuitive but possible.
Approach 1: Let’s say you redeem your investments worth Rs 45,000 to fund the purchase. The exit penalty and tax cost add up to Rs 4,000.
Approach 3a: You go with No-cost EMI for 9 months. Rs 5,000 per month for 9 months. But where will the money for EMI come from? We somehow manage. You might be able to rationalize expenses for a few months and manage to pay off the EMI WITHOUT reducing your monthly investments. This is not uncommon for middle class families.
Approach 3b: Even without a No-cost EMI, let’s say you convert your credit card purchase into EMIs at 15% p.a. for 12 months, you will have to pay an EMI of Rs 4,061 per month. That’s a total of Rs 48,739. You pay Rs 3,739 extra in interest cost.
You had paid Rs 4,000 in exit penalty and tax cost in Approach 1.
You might argue that there will be a tax impact whenever you sell the investment (if not now). That’s right. But the long-term capital gains face a much benign tax regime compared to short term capital gains. Another argument is that a loan will cost 15% p.a. (post-tax) while the investment does not guarantee such high post-tax returns. Valid point. Case closed. However, I can think of permutations and combinations where credit option can be a better choice.
Let’s say you open a FD of Rs 2 lacs five years back at 9% p.a. You need to fund a purchase of Rs 45,000. You break the FD (incur a penalty of say 50 bps), utilize 45,000 and put back the remaining Rs 1.55 lacs in a new fixed deposit. But the new FD rate is only 4.5% p.a. Instead, you could have taken an OD facility against the FD and pay it off in the next few weeks or months. The OD interest might be lower than the penalty cost and interest forgone.
Please understand that I am not saying Approach 3 (credit) is always better than Approach 1 (investments). All I say is that look at the credit option objectively. Weigh in the costs. The credit option might indeed be a better choice.
We talked about objective analysis. There is a subjective angle too, that of discipline. Once you start selling investments for a purchase, you might do that again. This might become a habit. After all, what are the investments for?
Approach 2 (Stopping SIPs) vs Approach 3 (Credit)
I work with many investors. My limited experience is that once SIPs are stopped/adjusted downwards (Approach 2), the monthly investments do not recover soon. The usual refrain is I am expecting one expense or the other. Let’s increase after a few months.
Just like work spreads itself in available time, idle money finds expense outlets. The money gets spent. Again, an investment discipline issue. In fact, taking Approach 2 has no cost attached. It is just the discipline issue. However, isn’t that a big issue?
The Risk with Approach 3
Approach 3 is only for responsible borrowers. You might be able to manage 1 EMI of Rs 5,000 for a few months. Not 4 EMIs of 5,000 each. If this EMI fondness (easy credit) makes you spend frivolously, you will soon find yourself in debt problems.
This makes Approach 3 very risky and not the right approach for most buyers. However, if you are responsible with credit, be open to various options (Approaches 1, 2 and 3) and decide accordingly.
PS: The purists (those who despise debt) might question the need to purchase a laptop worth Rs 45,000. Why not a cheaper laptop? While their argument has value, I think much of this is apathy for human needs, aspirations and behaviour or even outright snobbery. Not everyone is privileged. In this example, I am speaking about a hardworking person who has been diligent with his/her investments.