FINANCIAL PLANNING: Who will win the fight – EMI or SIP?

Behaviourally, spending money makes us happy and saving is boring. Easy access to credit feed our craving for instant gratification, thereby making us live on future earnings.

Should I buy the car on Equated Monthly Installments (EMI) or invest in monthly Systematic Investment Plan (SIP) and buy it outright without the loan burden? What’s right for you?

EMI (Buying the car on loan) – Assume that you plan to buy a car of Rs 11 lakh by availing a loan of Rs 10 lakh, at an inter of 9.5% per annum for a period of seven years (that is, 84 months). The EMI for the Rs 10 lakh loan would be Rs 16,265. The effective payment over the life of loan of seven years would be Rs 14.66 lakh an additional interest pay-out of Rs 3.66 lakh.

SIP (Investing to achieve the goal) – On the other hand, instead of EMI of Rs 16,265, if you invest the same amount (Rs 16,265) in Mutual Fund via SIP generating a return of 10% per annum to accumulate the car value of Rs 11 lakh (please note I haven’t factored inflation on the car value because the technology advancement hasn’t increased car prices much; on the contrary there is a much wider choice with more advance features in the same price range. SIP of Rs 16,625 over the next 4.5 years (that is, 54 months) adds to a principal investment of Rs 8.98 lakh. In reality an investment of Rs 8.98 lakh buys the car worth Rs 11 lakh.

The actual saving, which is actual payment made by EMI route minus actual principal investment via SIP, works out to Rs 5.68 lakh (that is, Rs 14.66 lakh minus Rs 8.98 lakh). The car effectively comes at a cost of 60% of the total payment made via the EMI route.

Now, the choice is bewteen buying the car now and paying almost 60% more or delaying the buy for 4.5 years and saving almost 40%. It is a choice between instant gratification v/s delayed gratification…choice is yours.

For whom car loan make sense?

Businessmen can actually buy the car on the company name; debit all the car related expenses such as (EMI, annual insurance costs, driver expenses, fuel expenses and any other car maintenance expense) and also avail depreciation benefit to reduce their tax liability.

Are all EMIs are bad?

Let us understand what are good loans and what are bad loans?

Good loans – Home loans and education loans are good loans. The former is taken for an appreciating asset while the latter is for upgrading our skill set enabling us to earn better. Secondly, both provide tax relief and are generally available at a competitive interest rate.

Bad loans – Loans such as credit card loans, personal loans, pay-day loans from online portals and consumer loans are all bad loans. They are taken for either depreciating assets or consumption; do not carry any tax benefits and are mostly expensive loans; for example, a credit card would charge a monthly interest rate of 3% thereabout, some pay-day loans quote 0.1% per day interest rate, effectively charging at 36% per annum.

Logically speaking EMI is good provided it is for good loans. However, whenever it comes to depreciating assets or consumption loan, it would be prudent to save via SIP and then buy it upfront. Instant gratification may delight but patience has its own virtue.

Having said that let me throw some light on why we are rationally irrational. Our brain has three layers: The Top-layer (Neo-Cortex); the middle-layer (Limbic Brain); The inner-brain (Brain Stem & Cerebellum). The Neo-Cortex is the logical brain, the Limbic is the emotional brain, whereas the Brain-stem & Cerebellum is the instinctive brain.

Whether it is an impulsive buying decision or a well thought out buying decision both get initiated at the Limbic brain and have emotions attached with it.

The fight is actually more intense than just EMI v/s SIP; it is a fight between instant gratification v/s delayed gratification; it is a fight between your emotional v/s logical part of the brain.

Well, I will not be surprised if you read this article and yet opt for a car loan!