New Delhi: It's good to have assets. Yes it’s important to have a communicator or blackberry in work circles. It is nice to have your child learning the piano and nicer to have a piano at home taken on 18 per cent personal loan.
It’s nice to be able to replace your old Maruti Esteem with a new Toyota Corolla costing you an installment of Rs 12,000 a month. It’s important to have such items as they bring us happiness and place us on a higher stratum of social status.
These assets give us a lot of satisfaction and because we feel we can afford it we undertake such purchase decisions.
The only problem is that these assets do not appreciate over time. In fact they depreciate, and worse, they give us a liability to live with for many years to come.
As soon as you drive the car out from the showroom it loses anywhere between 10 to 20 per cent of its value. Are we then saying that we should not purchase such assets? No. But there is a way of doing this.
We all know there is merit in buying house property, commercial property, gold, stocks, mutual funds and so on. All these are appreciating assets. But here, we shall focus more on how to buy those important but depreciating assets.
There are two scenarios when you would be buying a depreciable asset, like that blackberry, piano or car.
You either buy it now or at least within the next one year or you buy it after that.
Suppose you are buying it now or within the next one year.
Here again, there are 2 choices –
1. You either do not have enough money to buy the asset outright and hence opt for a loan OR
2. You have the money to buy the car outright
If it’s a loan you are opting for, the first thing to check is your affordability for taking loans. Consider your gross income per month. Next add all the loan installments on depreciating assets that you are currently paying and divide this figure by your gross income.
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If you get an answer of more than 0.2 or 20 per cent it is not advisable to buy that asset. An ideal level of loan servicing for depreciating assets is 15 per cent of your gross income and can be stretched maximum to 20 per cent. Beyond that it is not advisable.
Hence either you need to retire some old loans if possible or you have no choice but to delay such a purchase. You do not have to really regret in this case, as you will always have better choices later. For instance, the communicator will get outdated in six months or newer car models will keep hitting the market.
If you have the money to buy the car outright, a bit of smart financial planning can actually let you have that car for free. You could take a loan and invest your own money into a portfolio that generates income that is equal to the EMI (equated monthly installment) of the loan.
That way, your own funds remain intact while the cost of the car gets taken care of by the income that your portfolio is generating. Effectively, your car comes for free. Now the important question is how much corpus you have, what rate of return you must earn and how that corpus should be managed.
This is where some delicate calculations need to be done based on the risk you are willing to take, your understanding of financial markets and ensuring you have liquidity and flexibility in your investment strategy. For instance, equities today are delivering over 100 per cent returns in a year.
But along with that comes a high risk. Your ability to generate returns to beat your EMI depends on how you can balance the risk return equation.
Now suppose you are planning to buy the car or asset after a year.
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Again,
1. You either do not have the money to purchase the asset on outright basis OR
2. You have the money to purchase the asset on outright basis now or will have later.
If you do not have the money, you need to first create a corpus of money which when invested will earn you an amount atleast equal to the interest cost you will have to bear in the first 12 months of your loan repayments. It is easy to get a break up of interest and principal payments from your lender. This way you have atleast shielded yourself from bearing additional cost of depreciating asset purchase.
And if you have the money or will have the money in a year, the smartest thing to do would be to have a corpus to earn an amount not only equal to the interest burden but also cover some part or ideally full principal. In other words you should earn enough to cover the total installment. You know what will happen here – your depreciating asset becomes practically free of cost! Your corpus of money remains intact.
Again, the important question is how much corpus to have, what rate of return you must earn and how that corpus should be managed.
Remember a simple rule: “Depreciating assets must pay for themselves because over time they will have little or no value.”
Such methods of buying depreciating assets are also a part of prudent Financial Planning. Financial Planning shows you a roadmap of how not to compromise and how to optimise money even while you are purchasing a depreciating asset.
Author Kartik Jhaveri, an expert at Financial Planning, is a Certified Financial Planner and a Chartered Wealth Manager.
Disclaimer:
The contents of the above articles are the intellectual property and copyright of the author, Kartik Jhaveri. No part may be used or reproduced in any form or manner. This article is purely educative and you are strongly advised to consult an expert prior to taking any significant decision. If you choose to act upon the information contained in the above article it is at your own risk.
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