The Hindu Business Line : Repay or invest?

Like most things of life, the key decisions on personal finance management are based on common sense and understanding of one’s preferences and constraints. People with secured and rising income can venture into more risky but potentially high-yielding investment strategies and vice-versa.

Another important aspect of investing is being regular and systematic. More often than not, ad hoc and impulsive investment decisions lead to unsatisfactory results.

One of the common dilemmas we face in our everyday management of personal finance is whether we should prepay our existing loans with surplus income or keep the loan repayment at the contractual minimum and invest the surplus income.

The standard answer to this question is clear — one should prepay the loans with surplus income if the expected return on investment is lower than the interest rate (and other costs) on the loans and vice-versa. But the future is uncertain. Therefore, having a clear view on future return on investments and future interest rates on existing loans is not possible.

Moreover, the ability and willingness of individuals to take risk also varies widely. As a result, the standard answer to the question — should I invest in markets or should I reduce debt — has to be customised for specific conditions and particular individuals.

Choose with care

If an individual invests surplus fund from current income into the market without prepaying existing loans, this entails leveraged investment. This is a high-return, high-risk strategy. Only people with high risk appetite, sound financial backing, long investment horizon and strong knowledge about market investment should adopt such strategies.

On the one hand, even if the choice of market investment is correct, unforeseen short-term fluctuations can sharply reduce the value of investment and force the individual to liquidate such investment, resulting in huge losses.

On the other hand, leveraged investment allows an individual to take advantage of a market situation even without having “own money”. Apart from various attributes mentioned above for the success of such an approach, this also requires active investment strategy. That is, the individual should have ample time to closely monitor the market behaviour so as to change the course of investment as and when required by the developments in the market. So people with such acumen can contemplate adopting this strategy. For others, which means most of us, a more conservative approach is more appropriate. Under this approach one can pay the outstanding debt depending on income-expenditure pattern and invest only the surplus own income in instruments, which suits the risk profile of the investor.

Expert advice helps

Part of the problem of an active and/or leveraged investment strategy in terms of requirement of market knowledge and time can be averted by taking professional advice from qualified investment advisers. Even under such a situation, however, the investor following active and/or leveraged investment strategy should have large risk tolerance, long investment horizon and strong financial strength to deal with large change in personal assets and liabilities.

When the financial markets are doing well, there is always temptation to throw caution to the winds and try to deploy surplus fund into the market without repaying existing debt. Such an approach is fraught with risks.

In particular, those who should avoid adopting leveraged investment strategy include people with lumpy income and expenditure profile, those with low risk tolerance and people with relatively short investment perspective.

(The author is co-founder & Vice Chairman of Anand Rathi Financial Services.)

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