Saving through an SIP for making big-ticket purchases like a smart television or funding your holiday makes more financial sense than taking the EMI route and paying up over a period of time
In January last year, Kaustuv Majumdar, 40, took a trip to the Andamans with his family. The idea of the holiday surfaced just about two months ago in November 2016 when his sister’s family visited him in Kolkata. He estimated the total cost of the trip at around ₹ 50,000 for a family of two adults and one child. What he finally spent on the holiday was more than double his estimate— ₹ 1.12 lakh—which he funded through his credit card that he repaid through EMIs. In the end, what he finally shelled out was ₹ 1.33 lakh, including the interest and other charges he paid to the credit card company.
When Majumdar enquired about the interest rate on credit card EMIs in October 2016, his bank quoted a rate of 1.39% per month. But, two months later, when he converted his bills into a credit card loan and chose to pay through an EMI for 12 months, the bank raised the rate to 1.59%, excluding processing charges. He finally had to pay a 19% annual rate and spent about ₹ 21,000 over and above the total cost of the holiday.
“I didn’t have a separate fund for unplanned trips. Ideally, I should’ve planned it 6-12 months earlier because such trips are not very cheap," said Majumdar. He planned the trip in a hurry because his son and his sister’s child were about to join full-time school that year. “It would have become difficult for us to plan after our children joined school," said Majumdar.
Majumdar had to opt for an EMI because he had just quit his job to start a new business venture. He didn’t want to redeem his SIPs or FDs because he wanted to invest the money into his business. “If I were to go for a holiday again, I would plan in advance and save up for it instead of paying the bills through EMIs and shelling out more money in the form of interest," said Majumdar.
According to Bajaj Finserv Ltd, a financial services company focused on lending, about 6,000 to 7,000 people borrow money only for travel every year. Not just short-term holidays, EMIs are now available for purchasing electronics, furniture and even clothing which are all depreciating assets. Is an EMI for buying these products really worth it?
Sometimes you make quick decisions and end up spending on things or experiences you didn’t plan for. Advance planning, especially in case of holidays, does not work for a lot of people due to hectic schedules. And when such unplanned purchases or holidays happen, you may end up relying on your credit cards or other financing options and pay later through EMIs.
When you spend say ₹ 1.5 lakh on a holiday and then convert your credit card dues into an EMI for 12 months at an annual interest rate of 13%, at the end of the period, you would’ve paid ₹ 1,60,771 to your bank. This makes you shell out nearly ₹ 10,800 more than the actual cost of your holiday plus processing charges that your bank would levy while converting your payment into an EMI.
The shorter the goal, the lesser the risk you can take with your money, so choose the instrument carefully-
If you opt for a longer-duration EMI, say, for 24 months, the excess amount you pay would be close to one-fourths of the total cost of your holiday. An EMI for 24 months at an annual interest rate of 15% makes you spend an additional ₹ 24,500. Keep in mind that the more you extend your repayment period, the higher the rate your bank will charge. The interest rate on a 6- or 12-month EMI is lesser than that on a 18- or 24-month EMI. Other than this, your bank may charge you more if your payments get delayed or even if you prepay the instalments.
“Most people don’t think too much before taking an EMI. They are happy that money is available to them when they need it," said Shweta Jain, certified financial planner, CEO and founder, Investography. “Spending money becomes a habit and people realise it only later when things go out of hand."
“If you cannot afford a ₹ 20,000 phone and you buy it on EMI, it is a sorry tale of how your finances are. The best thing to do is save up and be okay with delayed gratification. It makes a lot of sense to keep aside your purchases until you free up some money rather than borrowing and paying more," said Suresh Sadagopan, founder, Ladder7 Financial Advisories.
Financial planners say when you purchase something with a fixed budget in mind and that is all you can afford, you will not be tempted to spend more. Whereas, if you pay through your credit cards or loans, you may end up spending a lot more because of the easy availability of money.
Separate money box
If you are someone who often makes unplanned purchases or have an insatiable wanderlust, what could possibly work for you is having a separate money box. Perhaps an SIP in a liquid debt fund would help you save sufficient money for the lifestyle you aspire for or the unplanned spending. Suppose you invest ₹ 12,050 every month in a liquid debt fund ( ₹ 1,44,600 a year), assuming an average return of 7%, you will get ₹ 1.5 lakh after a year. If you have more time before you take off for the dream holiday, then you will need to invest much less.
The longer time you have for investment, the less is the amount you need to invest due to the power of compounding. In our example, to get ₹ 1.5 lakh in a year at a return of 7%, your monthly contribution will have to be ₹ 12,050. But stretch your time horizon to two years and your monthly budget goes down by more than half.
“In an EMI you pay interest and in an SIP you earn interest. It is as simple as that but simple isn’t easy. If you plan that holiday earlier, you will start saving for it and earn an interest on your savings by investing in an SIP in a liquid or even an ultra short fund for your short-term goals. You also get the time to do enough research, decide on the best time to visit the place, and get a good deal on tickets," said Jain.
Compare your outgo on SIPs and EMIs (see graph), and you will notice how your savings keep increasing over time when you invest in SIPs and how you end up paying more and more when you extend the duration of your EMI. If you invest in an SIP for 12 months you shell out ₹ 1,44,600 but if you opt for an EMI for the same period, you spend ₹ 1,60,771, excluding additional charges.
While saving in a tool like SIP helps plan finances systematically, keep your investments in sync with your goals. The shorter the goal, the lesser the risk you can take with your money. It’s advisable to sit with your financial planner to understand how much to save and in which instrument. But what is not debatable is the fact that when you plan and save for a goal, not only do you savour it but you also spend less.