Many investors face situations where they need funds to tide over a sudden expense and are torn between borrowing or selling a financial asset like their mutual fund holding.
Our golden advice to our investors is to always build an emergency fund equivalent to up to six months of income to tackle this situation. This money should be parked in highly liquid and low-risk asset class. However many people don’t or are not able to follow this advice. Moreover, there may be situations when the requirement is far more than what your emergency funds can cover.
So what does one do in such situations? Borrow or liquidate?
I have a simple rule-:
The cost of capital for a loan or overdraft against Mutual Funds in India is around 11%. If you expect your Mutual Funds to give a return of more than 11% in the next 12 months then one should borrow.
If we expect a return below 11% then one is better off selling investments.
Now the decision moves to the market expectation around growth in the market. SENSEX had a return above 11% in 60% of the years in the past decade so the balance is towards borrowing. Further, one should always borrow if the market has seen a sharp 20% + correction recently and always liquidate instead of borrowing if the market has given 50% + return in two years or less.
If you had to make the choice today, I would still suggest borrowing even though it is a borderline case. My reasons are given below.
- The market has moved up by about 40% in the last 2 years there is still some upside from the technical perspective.
- Macroeconomic factors like rising oil prices, political uncertainty, interest etc are not at a great spot but underlying business performance and corporate results will support the upside.
Hope you found this useful.