There has been a lot of hype around getting loans using equity or debt mutual fund units as collateral. Many readers have asked if this is a good idea. In this article, we discuss whether loans against MF units are necessary.
The basic idea is quite simple. You pledge your MF units (to the extent necessary), and the bank uses them as collateral to offer you either a normal loan or an overdraft facility at 9.5-12% interest rates (variable). That is, the bank will own those MF units until you pay back the loan. It is a short-term loan, typically up to 12 months and can be renewed.
We have looked at all the so-called “benefits” and are not impressed: (1) You don’t need to redeem the units, they continue to earn returns, the long term “long-term compounding” is intact, (2) the interest rates are lower than a personal loan (but higher than a loan against FD); (3) In an overdraft loan, the bank will charge interest only on the amount drawn if it is lower than the max withdrawal limit (which is market-linked*).
* If the bond/stock market tanks or if there is a credit event in your debt/hybrid fund, the overdraft limit will sharply reduce. The thumb rule is that the higher the NAV volatility, the higher the interest rate.
Assuming the emergency was bigger than your emergency fund, why would you borrow when you already have the money to pay for an emergency? Just redeem from your mutual fund (or any other asset) and pay!
🔥Secure your future with our Robo-advisory tool trusted by over 3,500 investors and advisors. From effortless retirement planning to funding your children’s biggest dreams, turn your financial goals into reality. 🔥
Subscribe for money management solutions via email! (Link takes you to our email sign-up form) Join 32,000+ readers in our community.
👉 New Tool Alert! NaviPlan: A Privacy-Focused Multi-asset Tracker and Goal Planner 👈
This argument about “not losing long term compounding benefits by avoiding redemptions” is just an industry spin. The mutual fund industry will do anything to ensure we invest as much as possible and never redeem. A loan against MF units is just another gimmick to retain AUM.
First, while mutual funds are capable of good growth, they do not “compound” in the traditional sense. See: Don’t get fooled: Mutual funds have no compounding benefit! They do not offer a return higher than or equal to the loan rate year after year. So, a mathematical comparison of loan vs redemption or loan interest rate vs MF return is meaningless. Your unredeemed units could soar in value or tank, leaving you with a loan and lesser wealth (if your overdraft limit drops, you will have to pay the difference, or the bank will partially redeem your units).
Second, these loans are for a few months or, at best, 1-2 years. Sure, redemptions will affect the growth of wealth, but fresh investments can easily make up for this after taking care of the emergency without a loan.
A loan against MF units may prevent a redemption, but your future investments will be affected because you will have to pay interest. That will affect the growth of wealth as well. They don’t tell you this because the MF industry is not confident about you returning. So, they would rather push an option when they retain the money already invested. Remember, investor returns are always notional until redeemed. AMC (and distributor) returns (expense ratio and trail commissions) are always real – hence the drive to retain AUM.
We recommend that investors keep it simple. Build yourself a substantial emergency fund. Don’t stop contributing to your emergency fund (monthly 5% of take-home pay if possible). If your emergency costs more, then tough luck; redeem some investments and handle it. Then, focus on increasing your future investments and compensate for the redemption. Don’t complicate your already tough life with a loan against MFs. Just because it is easy to get does not mean it is necessary.
We are on Google News
Use this button to add freefincal.com as a preferred personal finance source on Google News.
Explore 1,000+ videos on YouTube!
Subscribe to get posts via email!
Join 32,000+ readers and get free money management solutions delivered to your inbox! (Link takes you to our email sign-up form)Join our WhatsApp Channel
Explore our products
🔥Join our community of 9000+ users! 🔥 Use our Robo-advisory Tool to create a complete financial plan! More than 3,500 investors and advisors use this! Use the discount code robo25 for 20% off. Plan your retirement (early, normal, before, and after), plus non-recurring financial goals (such as child education) and recurring financial goals (such as holidays and appliance purchases). The tool helps anyone aged 18 to 80 plan for retirement, plus six non-recurring and four recurring financial goals, with a detailed cash flow summary. Our Flagship Course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,500 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market conditions! Watch the first lecture for free! One-time payment! No recurring fees! Lifelong access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence. Join the freefincal investor circle! An exclusive space for investors, advisors, fintech employees and students to access financial planning and insurance tools, mutual fund and stock analysis tools, coding strategies and Excel macros for data extraction. 750+ members are now part of our investor circle. Increase your income by getting people to pay for your skills! More than 900 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner seeking more clients through online visibility, or a salaried individual looking for side or passive income, we will show you how to do it by showcasing your skills and building a community that trusts and pays you. (Watch the 1st lecture for free). One-time payment! No recurring fees! Lifelong access to videos! Track your mutual funds and stock investments with our Google Sheet! We also publish monthly screeners for- Equity mutual funds
- Debt and hybrid mutual funds
- Index funds
- ETFs
- Momentum and low-volatility stock screeners
Our Podcast: Let's Get Rich With Pattu
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Audible Link: Listen to the Let's Get Rich with Pattu Podcast
You can also watch podcast episodes on the OfSpin Media Friends YouTube Channel 
Listen to the Let's Get Rich With Pattu podcast on YouTube.
Now watch Let's Get Rich With Pattu தமிழில் (in Tamil)!About The Author
Dr M Pattabiraman giving a lecture
Dr M. Pattabiraman (PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over 14 years of experience publishing news analysis, research and financial product development. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free, AUM-independent investment advice. Connect with him via Twitter(X) LinkedIn YouTube Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (Published by CNBC TV18) for DIY investors. 
This book helps you ask the right questions and find the right answers. It also includes nine online calculators to create custom solutions.
(2) Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want. 
Both the boy and girl versions of "Chinchu Gets a Superpower".
Most investor problems stem from a lack of poor decision-making. We made bad decisions and money mistakes when we started earning, and we spent years undoing them. Why should our children go through the same pain? What is this book about? As parents, what if we had to groom one ability in our children that matters not only for money management and investing but for every aspect of life? My answer: Sound decision-making. So, in this book, we meet Chinchu, who is about to turn 10. The story follows what he wants for his birthday and how his parents plan it, while also teaching him key ideas about decision-making and money management. What readers say! 
Feedback from a young reader after reading Chinchu Gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from a young age. The importance of money management and decision-making based on their wants and needs. Very nicely written in simple terms. - Arun.
About freefincal & its content policy
Freefincal is a News Media organisation dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact Information: To get in touch, please use our contact form. (Sponsored posts or paid collaborations will not be entertained.)Our publications
Your Ultimate Guide to Travel
