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Why saving is better than taking loans to buy assets

Rather than taking loans to acquire assets, you should save more to build wealth over the long term. Here's why

ET CONTRIBUTORS|
Updated: May 13, 2019, 10.32 AM IST
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If a large chunk of the income goes towards paying EMIs, then very little is left for building any other asset.
Sameer is 35 and is servicing several loans—car, home and personal. His is a young family with a child and a homemaker wife. He is doing well professionally and is confident of being always gainfully employed, given his professional qualifications. Sameer thinks buying assets with loans is a good idea. He also treats EMIs as compulsory savings, and feels he would not have saved the money otherwise. What precautions should Sameer take given his liking for loans?

Sameer runs the risk of default if his EMIs are more than 50% of his income. In a typical household, a good portion of the income goes towards mandatory expenses. In a household with young children, the mandatory needs are likely to increase over time. Rising fees in private schools, fees for coaching and activities, costs of outings and travel are all likely to multiply. Sameer should enhance his savings to provide for these needs, and to do so he needs a higher monthly surplus. High EMIs will hurt this objective.

Second, loans will always have a higher cost than the return from the assets, except in the case of property, which may appreciate at a higher rate. However, a self-occupied home is not an earning asset. Assets such as cars depreciate in value. Therefore, Sameer’s logic about using loans to build assets may be flawed. He may be substituting his inability to save regularly with costly loans, which reduce his wealth, and reduce the flexibility to build assets he needs.

Third, Sameer’s portfolio may run the risk of being too skewed with a high proportion in property. If a large chunk of the income goes towards paying EMIs for a home loan, very little is left for building any other asset. Sameer should ensure that at least 30% of his investments are in other assets that are liquid, easy to access and flexible. He should build them as priority.

(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
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