Are you in debt ? Here’s how you can manage it.

While managing your personal finance, you may face a dilemma of giving appropriate weightage to either investment or debt. If you ignore debt repayment, compound interest spirals out and you may easily get into financial distress. If you ignore investments, then you may fail to accomplish your financial objectives.

Now, when you are already in debt, should you still invest money or wait till your existing debt becomes zero?

What if we tell you that you can invest and at the same time. Here’s how-

  1. Build a cash cushion

Before you begin investing or reducing debt, build a cash cushion first to secure yourself from an unanticipated emergency event that may occur in your life.

  1. Pay Off Credit card Debt

This debt usually carries an interest rate that is higher than what most investments will earn before taxes.

  1. Next steps

If you hold a diversified portfolio of investments that include both equities and fixed income, you may find that your after tax return on money invested is higher than your after tax cost of debt.

Case 1: 20 years loan – Outflow (EMI – 47922)

Case 2: 25 years loan + SIP of saving into the EMI (EMI 45302 + SIP 2600 = Total 47902)

In both the above cases monthly outflow is same, only difference is into the methodology. In first case, you are only paying EMI. In the second case by increasing tenure, you are making saving into the EMI and doing the SIP of that saving, making monthly outflow same as that in case 1.

After 18 years and 2 month, the value of SIP of Rs 2600/- per month assuming the 15% CAGR would be approximately Rs 26.29 Lacs, which can be used to fully repay the Loan outstanding. In other words, the outstanding loan principle amount would equal to the Fund Value of SIP after 18 years and 2 months.

In the whole process you would pay 22 EMIs less compared to Case one, making an absolute saving into the EMI worth Rs 10.54 Lacs.

By behaving this way you achieve several things

  • You minimize your tax bill, which means more money in your own pocket.
  • You reduce your debts over time. There comes a point at which they’re entirely repaid, and your free cash flow goes through the roof.
  • You only make riskier investments in taxable accounts once all of your other basic needs are met.

The Bottom Line

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.  With enough patience and hard work, this is a goal that you can achieve.

 

 

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