DEBT and investment are both powerful components of personal finance and both can be strategically used to achieve financial goals. While debt allows you to stretch your financial capacity through borrowing, investment allows you to grow your capital to meet your financial goals. However, a balance between debt repayment and investment is necessary. Let’s understand how to maintain the right balance between the two.
Why debt is important?
While reaching out for a loan to acquire unnecessary items is not a good financial habit, it might be healthy if you are trying to invest in an appreciating asset and your prevailing financial capacity does not allow you to attain it.
For example, if a person wants to buy property early in his career, he is unlikely to have ready funds due to income constraints. The best option in such situation is to go for a home loan, as the borrower needs to pay back the loan through EMIs over a period of time. Property owners also enjoy tax benefits for repayment through instalments.
Why investment is important
Money is of limited use if left idle at home. To meet your financial goals effectively, beating inflation, it’s important that you keep your money invested. Let’s say, the inflation rate in the coming years is expected to remain at 6% per year. This means that the value of your money would depreciate at 6% if hoarded and hence, you need to invest in instruments that ensure returns higher than 6%.
Investments also allow you to build a corpus in a structured way to meet specific future requirements. You can invest in short-term, mid-term and long-term instruments in order to fulfil children’s education, career and marriage, buying of a car or house and building a retirement corpus.
Timely allocation of fund ensures that you achieve a specific financial goal when you need to. If you do not invest money in the right time, your chances of getting good return diminish.
Debt repayment vs investment
You may want to invest aggressively while repaying your debt, but resources may be limited and you may struggle trying to pick the right one. It is important to prioritise debt repayment as you may become a defaulter and your credit ratings will drop.
However, you can’t ignore your investments either or fall prey to inflation for that matter. Both debt repayment and investment are important for a good financial standing. Your allocations for investment and spending should be clear and you should stick to your plan to avoid unnecessary loans. For example, if you are earning R50,000 per month, with a monthly expense of R25,000 and investment of R10,000, you have a repayment capacity of R15,000. You need do the math well in advance, so that you do not have to disrupt your investment plan.
If you find it difficult to take a decision, compare the rate of return on investment with the interest rate on the loan. If the latter is higher, it’s better to shift a part of your investment fund towards loan repayment. If return on investment is higher, prioritise investment over loan repayment.
The writer is CEO, BankBazaar