In the last post, I wrote about how I have combined my emergency fund along with my vacation fund. On one hand, this had the benefit of a larger fund in case of any exigency. On the other hand, a fully funded account afforded us the luxury of a vacation and so we are always excited to fund this account. You can find the detailed blog post here.
In this post, I want to take this one step further. Why should an emergency fund be something to be used only in an emergency? Why can’t I use it to fund any short term purchases? Beyond vacations, can I use it to buy a new phone or laptop, how about replacing a broken microwave or getting my house painted?
None of these scenarios pertain to the end of the world as we know it. But I still argue that using this fund to finance these purchases is better than any other form of loan.
Let’s say for arguments sake, we need to buy a new phone worth ₹50,000. A lot of us may not have that kind of cash lying around in our account. If you do have it, chances are you aren’t optimizing you investments appropriately. More on that later…
Funding with a Personal Loan
The first option would be to take out a short term loan to buy the phone. A personal loan from any of the leading banks has an interest rate of anywhere between 11.5% to as much as 34%. Even EMI options available on websites like Amazon come with interest rates of about 13-14%.
Interest Rates from the Major Banks
For the sake of this exercise, let’s assume an interest rate of 14%. Also, the tenure of this loan will be 1 year.
Based on this, we will end up paying ₹ 53,872 which is an extra 7.74%.
Cost of a Personal Loan
Funding with a Bajaj Finserv
The next option which is very popular is the Bajaj Finserv 0% EMI loans. This seemed a great option and I myself have bought a microwave and an Air-Conditioner using this. But when I had a look at the loan statement I saw a Subvention charge. This was 9.7% on one loan and 10% on the other. I guess the saying is true ‘There is no free lunch’.
Again, let’s take the lower charge of 9.7%. The tenure of this loan is 1 year.
Based on this, we will end up paying ₹ 54,850 which is an extra 9.70%, which is really the subvention charge.
Cost of Bajaj Finserv Loan
Funding with a Credit Card
The next option is purchasing using a Credit Card. This is probably one of the most used methodswith me having succumbed to using this a few too many times.
For the sake of this excercise, we are going to assume that we cannot pay in one shot. For an apple to apple comparison, let’s say we take a year to pay off the whole amount – principal and all.
Credit card debt is the worst kind of debt with annual interest rates as high as 40-50%. Total cost now becomes ₹ 61,483 which is a premium of a whopping 23%
Cost of Credit Card Loan
Funding with your Emergency Fund
The third option is using your Emergency Fund, which lets say is invested in a liquid fund.
Here let’s take the growth rate of 7%. Liquid funds have been growing at 8-9% in the last few years but we will consider the long term average of 7%. Again, the tenure of this investment will be 1 year. Liquid funds sold within three years of the time of purchase are added to your income and taxed as per your current tax slab.
Based on this, we will end up paying ₹ 48,680 (including capital gains taxes) which is a discount of 2.64%.
Liquid Fund Gain
From the analysis shown above, it is clear that funding the purchase with your credit card, where you cannot pay it off in the next billing cycle is the worst.
Surprisingly the 0% EMI Bajaj Finserv loans are a pretty bad option too. This is for a 1 year scenario and it warrants a deep dive which I will do in a subsequent post.
From a behavioral standpoint, having a fund named an ‘Emergency Fund’ implies it should be used in times of extreme exigencies. It is not extra money to blow up on every whim and fancy.
If you do not have the discipline to plan your investment properly, i urge you to have a separate account to fund this.
More importantly, the point of this post is to show you that if you plan your purchase, or for that matter even if it isn’t planned, you should look at using an investment vehicle like a Liquid Fund to fund the purchase rather than take on debt.