Recipe For Financial Freedom

This might seem huge risk to any body who is reading this. I have applied for a loan from my employer. As per the service rules of my company I am eligible for an interest free loan of Rs 50,000/- payable in 10 equal installments. This loan would put me in some more debt (you can see my current debt position here), but this would be the first time that I would be using the debt amount for leveraging my financial position.

For me I cannot see idle cash sitting around with me and doing nothing. I want it to get moving and for this reason i went for that loan. The options that I haveafter taking the loan are:

• Pay off debt
• Invest in Tax Savings Instruments
• Purchase of Mutual Funds
• Go to the stock market

Pay off Debt: I can pay off my debt but with a little calculation I found that the charges to pre-close my existing debt would be more than the interest to be paid on the loan tenure.

Learning: No learning just that you don’t take debt to spend the money on frivolous things.

Tax Saving instrument: Since I did not planned for the taxes this year this might be a good option to utilize the loan. The these instruments are inherently low return instrument, and has a lock in period of three years (in India).

This alternative can be considered if you are risk averse investor or in the age bracket of 45+. For me I have a better alternative of investing in mutual funds or direct equities (individual stocks)

Learning: If you have not planned your taxes from the beginning of the year don’t try to do it now as it would affect your finances in terms of opportunity cost.

Purchase of mutual funds is not for me! I am unmarried and in my late twenties, I can afford to take risks with the stock market expecting a better return that a mutual fund would give in a year. Moreover it is not a good idea to invest a bulk amount to invest in mutual funds you should always go for a Systematic investment cplan or an automatic clearing mechanism having a Rupee cost averaging over the period of investment..

Learning: Your age and your risk appetite determine the asset allocation you opt for.

Stock Market: The last option for me is to go to the stock market and invest in direct equities. I was planning for the same after evaluating all the above options and figured out 2-3 companies to put my money in. Some day back IPO of Reliance Power was announced and I now intend to apply for the same maxing out the limit for a retail investor. The idea behind going for the IPO with borrowed money is that any returns that I get in the buoyant Indian market would be a positive inflow as the cost of debt is zero.

Learning: I am under leveraged as far as my equity investments are concerned. Using other people’s money would increase my Return on Investment, within ten months this would increase my networth by more than 50,000 (50,000+ capital appreciation) by that time I would be out of this loan. The capital appreciation would be the time value of the money that I am borrowing.

This would be the first time I am going to use debt to invest. The reasons are simple. First, The cost of debt is nil, not even processing fee. Second, I am not purchasing consumables/luxuries with this amount.

Word of Caution: Some people might do a similar thing by taking a personal loan and then put it into the stock market but remember that would be a huge risk you would take as the cost of borrowing would be too high in this case and the stock market returns even if higher will not be substantial even to beat the inflation. Just have a look at the following illustration. (The interest rates are the prevalent rates in India)

Loan Interest Rate (Flat Rate including the processing fee) 14% per annum
Expected returns from the market (for one year) 20% (returns for the year 2008)
Inflation 5-6%
Your return 0%-1%

So the people who want to go for the stock market ride on their personal loans it’ll be a big disappointment for them by the year end. For people who have huge risk appetite should wait for the budget 2008 scheduled to be out in February which will set the tone for the markets.

As for me I would invite any suggestions for the loan money to be invested. I am going to put that money into stock market on 17th of January 2008.

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