While managing your personal finance, you may face a dilemma
of giving appropriate weightage to either investment or debt since both are
important aspects of your personal finance. If you ignore debt repayment, then
compounding interest will quickly spiral out and you may easily get into
financial distress. If you ignore investment, then you may fail to accomplish
many of your financial objectives. So, it is important to maintain the right
balance between debt and investment.
Now, when you
are already in debt, should you still invest money or wait till your existing
debt becomes zero?
To invest or avoid while in
debt
Certain important factors like interest rate can help you
decide on whether to invest or pay the debt first. If the existing and expected
interest rate on debt is substantially lower as compared to the interest or
return you expect to earn from an investment, then you should prefer to invest
over prepaying. For example, prevailing interest rate on a home loan is around
8.5 percent p.a. and you have earned extra income through annual bonus. You
have the option to prepay the loan or to invest the bonus in a balanced fund, which
is expected to give a return of 12 percent p.a. (assumed) after tax. In this
case you, should continue to pay home loan EMI and use the fund for investing
in a balanced fund to earn a better return, considering a risk while investing
money in a mutual fund.
If the interest rate on loan is close to or higher than the expected return
from investment, then use your extra income to first clear the outstanding debt
and thereafter use the remaining fund, if any, for investment in appropriate
instrument.
Assessment of existing liquidity
Another important factor that you must check before using the
income to pay debt or invest is to assess your prevailing liquidity situation.
If you find it difficult to manage your regular monthly expenses after paying the
EMI, then using the surplus income for repaying such debt could
help you to reduce the financial burden.
Repaying the debt on time is very crucial for maintaining a
good credit score. If you have surplus fund and you invest it, then do assess
whether you will be able to liquidate it at the time of emergency without any
capital loss. If yes, then you can think of investing money over prepaying the
loan amount. For example, if you face financial emergency, such as job loss or
an accident, and you don’t have enough money to repay existing debt EMI, then
you can use this investment for emergency cash flow. However, if you are not
sure about retaining the value of investing funds and its liquidity factor,
then it is better to avoid such investment.
Invest surplus in appropriate instrument
If you are planning to take a loan for other big ticket
purchases, then instead of using the surplus income to repay your existing
loan, you can use it to invest in appropriate instrument and later on use it to
pay for your buying. For example, you are planning to buy a car after three
months and you got a surplus income of Rs. 5 lakh. You have an existing home
loan with Rs. 20 lakh outstanding and remaining tenure of 15 years, with an
interest rate at 8.8 percent per year. Instead of using the surplus income to
repay your home loan and taking a car loan to buy a new vehicle, you should
invest it in a liquid fund for three months. The invested money can come handy
later on for your car buying.
It's important to maintain
a balance between risk and reward
To make a
correct decision you should focus on maintaining a fine balance between risk
and reward while selecting one of the options. You must analyze the impact of
your decision on your retirement goal and your other financial objectives. Try
to cut down the risk associated with your debt by utilizing the reward you
expect to get by investing the fund.
Team WealthyMantra
Source: Moneycontrol
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