How a SIP works more for you than an EMI?

With increasing space and time crunch in cities and suburbs, four walls and a roof for a sound sleep is what a common man yearns for. The want for having something that is yours is fairly justified. A young investor buys a home for his family and acquires a vehicle to drive around, mostly covered by a loan with an EMI (Equated Monthly Installment). But, EMIs are potentially detrimental to one's mental satisfaction. Also, there are other schemes that provide a much better rate of return than the asset acquired under an EMI.

One scheme that could work in your favor, more than an EMI does, is the SIP. SIP (Systematic Investment Planning) is nothing but a specified amount that is invested in a scheme for a continuous time period, at regular intervals.

Analyzing the Idea

The fundamental here is clear and simple; EMI is negative compounding, while SIP is positive compounding. For starters, it is to be understood that towards the end of your loan EMI period (which is usually a few years), you actually end up paying a significant amount more than what the asset's actual worth was. The difference in between both these investment systems can be elaborately explained by a simple example.

Let us imagine you have an EMI tenure of 20 years, of which Rs 20,000 is your EMI. Also, assume that the loan amount would be 80% of the house's purchase price (20% down payment by the buyer), all at an interest rate of 10.5%. Calculating, we see that the interest payable goes up to Rs 27,90,000. The total payable amount, against the Rs 20 lakh loan amount, shoots up to a significant Rs 47,90,000. Basically, one is paying back more than double of what he's borrowing. Taking in all the aspects, assume the value of the asset 20 years later may be somewhere around 5 times the current value, which would be Rs 1.25 crore.

In an alternative scenario, you decide to invest your money in SIP. Let us say you live in a rented flat costing you Rs 9000 rent per month. Comparing with the provisions above, you would still have Rs 11,000 to invest in a SIP. Assume that the general inflation rate of 6-7% and the increasing rent is checked by other factors. At an expected return of 15%, calculations for the period of 20 years showcase the return to be Rs 1.7 crore. Against the invested Rs 26.4 lakh, your net wealth gain will be Rs 1.4 crore (excluding rent payment of the rented flat).

	Asset Bought Through Loan	SIP
Down Payment	Rs 5 lakh	-
Monthly Installments	Rs 20,000	Rs 11,000
Loan Amount	Rs 20,00,000	-
Rent	-	Rs 9,000 (with 5% yearly increment)
Total Investment	Rs 52,90,000	Rs 48,75,000 (Including rent payment of the rented flat)
Expected Rate of Return	Five times the current value	15%
Returns After Time Period	Rs 1.25 crore	Rs 1.7 crore
Observed Wealth Gain	Rs 72,10,000	Rs 1,21,25,000

Summing It Up

The table above speaks about SIP and its benefits at a length. The observed wealth gain does show a huge gap in investment through SIP and asset bought through loans. It would, hence, seem wiser to be on the more patient side. With a longer term vision, SIPs provide unmatchable returns, which would further help you once you enter the post-retirement stage.