Mutual Fund Awareness 109: Debt Financing everything else except your Retirement

Let us first start by defining what “Debt Financing” and “Retirement” are before we explore the possibilities of linking them together.

1. Retirement: Is the process of meeting your future expenses after your active income stops.
2. Debt Financing: Is the process by which you are borrowing funds to meet a need today. Most often, by taking a loan from a financial institution.

Earlier retirements were typically attributed to old age (say 60 or above), where a person was no longer physically fit to continue employment. The nature of jobs was physically challenging in the Industrial Revolution; people usually labored on the shop floor, welding, smithing, smelting, constructing, maintaining, etc.

The jobs required more of physical activity than mental. Since these jobs were tiring, it was pretty challenging for people above 60 to continue working; hence, the employers forced these aged people to leave the workforce. Industrialists and Business owners coined the concept of retirement to maintain labor productivity by replacing old workhorses with new ones.

The new age businesses require more mental activity and emotional intelligence than physical labor. The mental activity and wisdom do not slow down with age as much as the physical strength/endurance. This is why most politicians and chairpersons of big conglomerates are in their 70s or above.

Ideally, we expect more people to continue in the workforce, and the term “retirement” to fade out, but the opposite is happening. The trend is people preferring to leave the workforce in their 40s and 50s, taking time out to enjoy life, travel, and experience the world.

Loans are attractive financial products that offer you leverage today, albeit at the cost of a bit of your future. Ideally, it is a simple concept — If you do not have money today to afford something, you can borrow it from someone with a promise that you will repay it tomorrow.

Being a leveraged product, loans will amplify the effect, good or bad, proportionately. In other words, if you secured a good loan, you would likely achieve good results. Similarly, if the loan is bad, you would end up screwing your future.

An individual can take a loan for almost anything, except for retirement. That’s because retirement usually means different things to different people, and the banks would end up confused about how to fund it. Let us look at the options of loans available.

1. Education Loans
2. Car Loans
3. Gold Loans
4. Housing Loans
5. Loans against property
6. Agricultural Loans
7. Loans for Marriage
8. Vacation Loans
9. Personal Loans
10. Credit Card Loans
11. P2P lending Loans
12. Business Loans

These are some of the main heads under which a person can apply for the loan. When you approach the bank, they know the type of credit-audit they need to do when you state the purpose of the loan. But if you ask them to give you a loan for retirement, they would just be as confused as you are.

Besides the actual retirement, you can take loans for everything else. So, what kind of loans can you take to create a perfect retirement plan?

The answer is — good loans. The definition of a good loan is the one “that helps you create assets”. When you create assets that later generate income for you, you can manifest the perfect retirement setup.

The problem is that people take loans to fund their liabilities. Once they do that, they are manifesting a future with negative cash flows, because liabilities require upkeep and a constant influx of capital.

Take a moment to assess your outstanding loans. Check if the loans are building assets or liabilities. If they are creating assets, your retirement pathway is perfectly lit. If they are liabilities, then the light at the end of the tunnel will never arrive. By properly planning the “good loans”, you can create a retirement profile as per your financial appetite.

The idea is to reverse engineer it, start with the end in mind. For example, if you wish to retire at the age of 50 and require a monthly income of 2 lakhs, the procedure to calculate the required assets is as follows.

1. If you are 40 years old, your retirement is 10 years away.
2. If your current monthly expense is 2 lakhs, you need to calculate its equivalent 10 years from now. If the inflation is assumed at 5%, then the monthly amount required 10 years from now = 325778 {=FV(5%,10,0,200000)}.
3. This monthly income is assumed to be coming from the interest income of the asset. The yearly outgo = 325778×12 = 39 lakhs.
4. If the investment is growing at 13% per year, then the asset size required is 39L/13% = 3 crores.
5. If you wish to keep everything in a debt mutual fund, growing at 6% per year, then the revised asset size would be = 39L/6% = 6.51 crores.

The idea is to create an asset of size between 3 crores and 6.51 crores in 10 years. The plan is to use debt to find or build those assets.

If you’re unsure whether your loans are building assets or fuelling liabilities, consider seeking external help. Any loan consultant could help you with that. A loan is a non-linear financial product with leverage, so the customer usually ends up underestimating the impact it has on their future.

The assets that could be debt-financed could be

1. Education loan — as long as the higher education is improving your capability to earn.
2. Housing loan — provided the house/apartment generates rental income or has a potential capital gain in the future.
3. Gold loan — has minimal damage to the person, in addition to the gold kept as collateral.
4. Business loans — As long as the company you are running is creating incremental and positive cashflow.
5. Agricultural loans — As long as the produce is going up and the scale is improving.
6. Automobile loans — If you are running a taxi service or use it as an intermediary product, and it is generating income for you.

Buying mutual funds with a loan? Absolutely Not.

I wrote this article because one of my clients called me last week to say she is getting a low-interest loan from a self-help group for women. She asked me if it’s a good idea to borrow money and invest in Mutual Funds. The short and long answer is NO.

Both mutual funds and loans are non-linear financial products; both of them have leverage, but it’s not advised to buy a mutual fund. A mutual fund may require some time to start generating results; it could be 3 years, 5 years, or maybe 10 years. A loan, on the other hand, has a due date in the coming month. The issue arises when you have an EMI to pay, but the asset you are building is in RED, which can lead to psychological self-doubt.

All other assets, including land, buildings, and properties, do not experience daily valuation fluctuations like mutual funds. This keeps your mind focused on the original investment course.

Mutual funds are also a proper asset class, but the daily, weekly, and monthly volatility is more than enough to spoil your focus. This is why you should never borrow to invest in a mutual fund.

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