Who will win the fight - EMI or SIP?
Behaviourally, spending money makes us happy and saving is boring. Easy access to credit feeds our craving for instant gratification, thereby making us live on future earnings. Should I buy the car on Equated Monthly Installments (EMI) or invest in monthly Systematic Investment Plan (SIP) and buy it outright without the loan? What’s right for you?
EMI – Assume that you plan to buy a car of Rs 11 lakh by availing a loan of Rs 10 lakh, at an inter of 9.5% per annum for a period of seven years. The EMI would be Rs 16,265. The effective payment over the life of loan of seven years would be Rs 14.66 lakh an additional interest payout of Rs 3.66 lakh.
SIP – On the other hand, if you invest the same amount (Rs 16,265) in Mutual Fund via SIP generating a return of 10% per annum to accumulate the car value of Rs 11 lakh (I haven’t factored inflation on the car value because technology advancement hasn’t increased car prices much). SIP of Rs 16,625 over the next 4.5 years adds to a principal investment of Rs 8.98 lakh. In reality an investment of Rs 8.98 lakh buys the car worth Rs 11 lakh.
The actual saving, which is actual payment made by EMI route minus actual principal investment via SIP, works out to Rs 5.68 lakh (that is, Rs 14.66 lakh minus Rs 8.98 lakh). The car effectively comes at a cost of 60% of the total payment made via the EMI route.
The choice is between buying the car now and paying 60% more or delaying the buy for 4.5 years and saving almost 40%. It is a choice between instant gratification v/s delayed gratification.
For whom does car loan make sense? Businessmen can actually buy the car on the company name; debit all car-related expenses (EMI, annual insurance costs, driver expenses, fuel expenses and any other car maintenance expense) and also avail depreciation benefit to reduce their tax liability.
Are all EMIS are bad?
Let us understand what are good and bad loans.
Good loans – Home loans and education loans are good loans. The former is taken for an appreciating asset while the latter is for upgrading our skill set enabling us to earn better. Both provide tax relief and are generally available at a competitive interest rate.
Bad loans – Credit card loans, personal loans, payday loans and consumer loans are all bad loans. They are taken for either depreciating assets or consumption; do not offer tax benefits and are expensive. A credit card would charge a effectively 36% per annum.
EMI is good provided it is for good loans. But when it comes to depreciating assets, it is prudent to save via SIP and buy upfront. The fight is actually more intense than just EMI v/s SIP; it is a fight between your emotional v/s logical part of the brain.
The writer is founder & CEO, Fincart