Who will win the fight - EMI or SIP?

DNA (Daily News & Analysis) Mumbai Edition - - FRONT PAGE -

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

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