Mutual Fund SIP vs Loan EMI: Which One Should You Choose?

The writer is a Delhi based Certified Financial Planner CFPCM, conferred upon by the
Financial Planning Standards Board. If you are an Indian resident looking for a financial plan prepared according to your needs & goals, write to her at shruti(AT)richesawait.com

These days it is very easy to purchase whatever one wishes for. Almost everything is available with a small down payment, be it the latest gadgets, home appliances or cars. You name it and chances are you will find an EMI or equated monthly installment solution for your desired purchase. Consumers looking for instant gratification are scooping up these offers like candies, they get to use the product right now and pay for it later, what’s not to like?

Well if you look closely you will be enraged!
Do you know how much extra you are paying for this so called ease and comfort? Lets understand this with help of an example.

Let’s say you want to buy a car of 7 lakhs. For this you pay 1 lakh as down payment and take 6 lakh loan @ 10% for 3 years. Now let’s understand how this 6 lakh loan works.

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For this loan you will pay an EMI of ₹19,360.31 for 36 months. While you may find this convenient, do you realise that you are paying around ₹96,971.16 in interest? This does not include additional costs like processing fees. So you end up paying closer to ₹8 lakhs for a 7 lakh car.
Imagine how much extra you will end up paying on higher interest rates. Because your car loses the most value in its first year, the biggest irony here is that while you are paying more than the actual cost for your purchase your car is trying to shed its resale valuation as quickly as possible.

What if I told you there is an alternative way to finance your purchase, where you don’t have to pay any interest, and the best part is you end up spending way less than 7 lakhs and still get your car? It’s like having your cake and eating it too.

This is possible with the help of an SIP. If you had created a short-term goal of buying a car and invested just ₹16,250.02 in a monthly SIP giving a 12% annual return for 3 years you would have your desired amount of 7 lakhs today and could purchase your car. This means that with just ₹585,000 you could have a new car of 7 lakhs, that is a clear discount of ₹115,000!

Here is why an SIP is better than EMI for you:

  • Compounding Factor
    There is no escape from compounding, it rears its head in both EMI and SIP cases. But the only difference is, in EMI compounding works against you and you end up paying more than the actual price in the form of interest. But in an SIP, compounding works in your favour and you end up paying less than the actual amount.
  • Flexibility
    EMI is a liability, you have to pay the fixed amount every month no matter what. Even if you are facing a financial crisis you have to arrange the money for the EMI. SIP is very flexible in nature, you can increase or decrease the SIP amount as per your situation. You can also stop it entirely if you find yourself in a tight fix financially.

Before going for an EMI option take a minute and think about what you are signing for. With just a little planning and time management you can save big amounts and avoid a debt trap.

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