Mutual Funds Investing Strategy 106: If you buy a 10 lakh car when you can afford a 20 lakh car…
The title is pretty confusing, right? I purposefully kept it confusing so that you feel amazed when we unwrap the contents.
Firstly, let us talk about buying a car. I have two friends @mightyoffroader, and @sunubabu who would kill me when I say a car is a liability. For both of them, cars are life. I used to be that way, but unfortunately, life has caught up and now the car is something that takes me from one place to another.
Today, we will discuss the difference between buying a 10 lakh car and a 20 lakh car. This article does not apply to the person who is buying the same with ready cash. When you deploy 100% cash, I am confident that it is the best use of your funds. Meanwhile, if you are taking a loan to buy the car, you should read forward and think with an open mind.
Case 1: EMI calculation for a 20 lakh car
Assumptions:
- The interest rate is 10%
- Tenure is 7 years
If you refer to the image, the monthly EMI works out to be 33202. Over the next 7 years, you would end up paying 27.88 Lakhs to own something that is worth 20 Lakhs today.
Case 2: EMI calculation for a 10 lakh car
Assumptions:
- The interest rate is 10%
- Tenure is 7 years
The calculations are pretty straightforward here, you end up having an EMI of 16601 i.e. 33202/2 when your loan amount is halved from 20L to 10L
Let us calculate what would happen if you purchased the 10 L car instead of 20 L car but set aside 33202 monthly payments. Every month you are ready to deploy
- 16601 as EMI to the 10L car
- 16601 as a SIP for a mutual fund
The results show that you will end up generating a total investment balance of 21.91L when you park 16601 as a SIP into a fund that gives an annual return of 12%.
Basically, no one can predict with 100% accuracy if the mutual funds will give an exact 12% return every time, but the historical data gives some ballpark figures to aim for. source
The final result says that you can raise a capital of 20+ lakhs if you cut your car’s budget from 20 to 10. At the end of 7 years, you will still have the 10 lakh car with you and almost double the money in your investment account.
This is not magic, but because of compounding. When you take a loan, compounding works against you and when you invest, compounding works for you. In the above example, you are losing heavily on the loan side and generating much more on the investment side.
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