The Hindu Business Line : Fund Talk

I am 30 years old. I have an offer from my bank for a pre-approved personal loan of Rs 2.5 lakh. The EMI will be about Rs 6,600 over 48 months. The rate of interest is 16 per cent per annum. Being a salaried person, paying that EMI is not a problem. Is it a good idea to take that loan and invest it in any diversified mutual fund for a time horizon of 48 months?

S. Sivaraman

Mangalore

It would be very unwise to take a personal loan to make investments in a diversified equity fund, even if you can afford the EMI (Equated Monthly Instalment). Investments in an equity fund (or indeed in stocks) always carry a risk to your capital. If the stock market declines after you make your investment, you stand to lose a part of your principal. Any stock market correction will deliver a double blow to your wealth. Apart from suffering capital erosion, which you will have to make up from your own funds, you will have to pay interest to the bank on the borrowed amount.

While making such a decision, you should consider the interest rate at which you are contracting the loan and not merely the EMI. Since you are borrowing at a stiff interest rate of 16 per cent, your equity investments will have to deliver at least a 5-6 per cent premium over this, to make the additional risks that you assume, worthwhile. Equity funds, over the last 4-5 years may have easily achieved a 20-25 per cent annualised return. However, sustaining such a return over the next 4-5 years appears quite challenging.

After the sharp rally in the equity market, Indian stocks are no longer significantly undervalued. Companies also face threats to earnings from rising borrowing costs and commodity prices. Under the circumstances, a 12-15 per cent annual return over the next 4-5 years may be achievable. However, even if this is achieved, it would not be enough to service your borrowing costs, leave alone fetch you an attractive return.

The other factor you should be aware of is that returns from an equity fund do not accrue in a steady fashion though they may even out over a 4-5 year holding period. There may be a few months, or even years, of flat or declining stock prices, followed by short bursts of activity in which stocks deliver impressive returns. Therefore, while your investment in equity funds fluctuate in value from month to month, the EMI you have to service will remain constant.

We would suggest that, if you do not have a lumpsum to invest, you could start a systematic investment plan on one or two diversified equity funds with a good track record. This would enable you to participate in any upside from equity investments, while evening out the risks associated with timing.

Aarati Krishnan

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