The system of giving loan by financial institutions has made the common man lazy and complacent. We take loans at the drop of a hat, ranging from home loans to vehicle loans to education loans to consumer durable loans to personal loans to mortgage loans to even availing loan to clear a loan!
Why do we prefer a loan over the idyllic habit of planning for events well in advance by choosing the saving and investing route? Let’s consider the example of a home loan which is the largest and the longest compared to all loans. The normal age at which one takes a loan is about 25 to 30 years, the early earning years of a young man. He struggles to mobilize the 20% down payment criteria and avails the balance 80% as loan and further struggles to clear the loan over the next 20 odd years.
Reduce the burdenToday, an ordinary two-bedroom apartment costs about Rs.50 lakh for which, if a loan is taken, Rs.10 lakh would be the down payment and the rest would be funded by a bank or an HFI. What would have been an ideal situation to have avoided taking a loan or at least reduce the burden of quantum of loan?
The solution for this situation would have been planning well in advance. If the father or the parent of the person who is borrowing today had set aside an amount of Rs.1,000 per month some 20 or 22 years ago in a diversified equity mutual fund he would have comfortably created a corpus of Rs.50 lakh by now (between 1993 and 2015). Evidences by way of Franklin India Prima Fund, HDFC Equity Fund, Reliance Growth Fund, and diversified equity mutual funds, can be proof enough.
Yes, these are real facts and figures. That would have been the perfect gift the parent would have given to the son or daughter by enabling and empowering the now adult child. Now what excuse can one give to nullify this opportunity? One hears statements such as “I did not know about this opportunity”; “I did not believe that equity mutual funds had this ability”; “Nobody told me about this”; and “I invested in a post office savings instrument for the same period, but it is not enough to avert a loan.” But let’s accept the fact that “ignorance cannot be bliss” and let’s also not forget that there are just a handful of investors who indeed invested small amounts (even larger amounts) on a monthly basis, systematically for these many years and have created wealth.
The same example of planning in advance for long-term events would be applicable for all sorts of future events that require a sizeable amount of money, yet the biggest asset one has is “time”.
If one has 20 to 25 years of time to meet events, then adopting risk into the overall investment plan would be a good idea. Sceptics may say they do not believe in the equity as an investment instrument, but such scepticism is at their own peril.
The EMI workoutFor the sake of calculation, if one takes a loan of Rs.50 lakh to buy a house at 9.50% rate of interest for a period of 20 years, the EMI works out to Rs.46,607.
Paying this for a period of 20 years, the total outflow on the loan amount would be approx. Rs.1.12 crore. Instead, 20 years ago if the parent had invested an amount of Rs.3,000 at 15% CAGR (compounded annual gross return) the required corpus of Rs.50 lakh would have been created and the loan would have been averted.
The example of 15% CAGR has been considered discounting the CAGR offered by leading mutual fund schemes that has generated above 20% p.a. returns over the same period. Another fresh year is fast approaching in just a couple of weeks. If you are a young parent or going to become a parent in the near future, think hard about these possibilities.
