Oct 30, 2023
“I have a balance of 50 lakhs in my savings bank account”, told an investor I met last year. On asking the reason of holding such a big amount in bank account, earning almost nothing in terms of interest, he explained that the amount has been kept handy for emergency situations.
This is not the first time I heard this statement. Many people hold large funds in savings account/FDs with an objective of safety and liquidity.
“Nothing wrong with that plan”, I said. Just that, firstly, the emergency need may or may not arise for years. Even if it arises, the requirement might be for few thousands or lakhs of rupees, and not necessarily of a large amount like 10-20-50 lacs which you currently have in your bank account. That means, may be for a need of couple of lacs, that may or may not arise in 1-2 years’ time, he is holding a large sum for years with no or low returns.
Secondly, with every withdrawal, these 50 lakhs lying in the bank account will decrease since there is no or low growth in this fund. To maintain the same level of emergency fund, he will have to add fresh money from his pocket. The growth is so negligible that it won’t be able to refill the amount withdrawn to maintain same level of emergency fund.
Thirdly, this large fund of 50 lacs lying in his bank accounts can double to one crore in 5-7 years if invested in growth funds. In fact, it would have already grown to a larger value of 60-70 lacs if it was properly managed over these years.
Lastly, on the little interest income he is earning from this fund, he is already paying 30% tax without utilizing the funds, which is an additional burden on him.
After hearing me, he seemed puzzled and asked if there was a solution which can provide him both growth and liquidity at the same time.
The Solution
It is certainly possible to provide growth to our emergency funds and have liquidity for various financial needs.
All this is possible with the help of a facility called Loan against Mutual Funds. Under this facility, various banks and NBFCs provide an overdraft limit against mutual fund holdings of the investors. As the loan is backed by mutual fund asset, interest rates are lower than that of a personal loan/credit card/high cost home loan and are normally in the range of 9%-10% per annum. The interest is calculated on daily basis only on the amount utilised at the end of the day. If there is no utilisation of the loan amount, there is no interest cost.
The overdraft limit can be utilized and repaid as and when convenient. There is neither any burden of EMIs, nor any penalty for early repayment.
Applying the features of this facility, the questions asked by the investor led to the following answers –
Q 1- Can the emergency funds be invested for higher returns and still money may be available for emergency needs?
A – YES, the funds would be invested in growth mutual funds earning 12-13% p.a. returns and emergency fund will be available in the form of overdraft limit sanctioned based on these mutual funds value.
Q 2- Is it possible that after a withdrawal, the emergency fund grows to its earlier level without he puts in more funds?
A – YES, the growth of funds invested in growth mutual funds continues even after taking loan against it, which makes the investor eligible for a bigger amount of overdraft limit in future. So, without putting in fresh money, his emergency fund, which is now in the form of overdraft limit, can be increased only with the growth of underlying investments.
Q 3- Is it possible have a flexible emergency fund, which can be used only if required and only for the amount required, instead of holding this large 50 lac amount?
A – YES, once overdraft limit is sanctioned, he can use it only if it is required. The interest will be charged only from the date of utilization to the date of its repayment. If there is no withdrawal from the loan account, there is no interest to be paid.
Q 4- Is there any way to save on tax? He is already in high tax bracket and paying huge taxes.
A – YES, if he utilizes money from the overdraft limit sanctioned to him, there will be no capital gains tax implication as he is not redeeming any of his funds. Even if he withdraws his mutual fund investments in future, flat 10% tax will be levied to him which is still lower than 20/30% tax that he pays on his FD interest income.
How to Use the Loans Against Mutual Funds Facility
Step 1 – Invest the emergency funds lying in savings bank account, FDs, RDs or any other low-return option to equity or growth mutual funds with an average return of 12-13% per annum. This will start the journey of your funds towards a higher return of 12-13% p.a. from 0-6% p.a.
Step 2 – Apply for Loan against mutual funds up to the limit allowed. Investments in equity funds would allow the investor to get a loan against mutual funds up to 45-50% of the total fund value.
With this step, a liquid, easily accessible emergency fund is ready!
Step 3 – Use when required – if any emergency occurs, the amount required can be easily used from the loan account by transferring it to the savings account instantly. Interest will be charged only from the date it is utilized to the date it is repaid.
Step 4 – Repay as per convenience – Repay the amount as and when surplus money is available or by liquidating investments partially. In fact, after repaying, it can be reused if it is required.
The beauty of the above solution is that the so-called whole emergency fund grows at a rate of 12-13% per annum whereas the interest rate is only 9-10% and is paid only on partial amount used. E.g. the investor may have 50 lac invested in growth funds which may gain 5-6 lacs in a year whereas the loan amout used may be 2-3 lacs only in emergency on which few thousand rupees interest may need to be paid. The loan amount may be repaid through own sources or by liquidating partial investment.
He took a note of all the points and realized the huge opportunity loss he was incurring over these years. Over the next few days, he took further details and opened his loan account. Now all his investments are in growth funds and interestingly there has been no need for any emergency withdrawal till date.
Advantage for Businesspersons
The solution works for businesspersons as well. Instead of liquidating their personal investments for business needs, they may use the same loan facility for their business needs like working capital requirements paying salaries & other fixed expenses on due dates, delay in receipts of payments from customers, making a big office purchase like furniture or any equipment, temporary slowdown in business etc. They can repay the loan amount flexibly when the business cash flow permits. The cost of such facility is much lower than other types of funds. Also, the loan amount is readily available without any formalities or further paperwork.
Over the time, this solution has worked well for different people in different ways. You may speak to us to know how it can be beneficial to your financial needs.
Conclusion
Investors may consider avoiding keeping large amount in low-return assets when the need of funds is uncertain. A significant value can be created by investing this amount in growth investments and using Loan against Mutual Funds facility for temporary needs. The growth of investments on full amount far outweighs the interest cost that is paid on temporary loan utilization.
Many investors are already using the solution and share their happy experiences. To know more and to discuss the benefits for yourself, do mail us at info@investguru.in or speak to us @ 9310722987.
Wishing you prosperity with peace!
Taneesha Bansal
Research Analyst, InvestGuru