We have all been there—in dire need of money suddenly and contemplating the redemption of our mutual fund units. It seems like a convenient choice compared to other investments like fixed deposits, provident funds, or even investment-linked life insurance. But, there are pitfalls to redeeming your mutual funds prematurely. In fact, there’s a lesser-known alternative that allows you to access funds without sacrificing the growth potential of your investments—lien your mutual fund units to generate a line of credit known as a ‘Loan against Mutual Funds’ (LAMF).
First, let’s delve deeper into the downside of redeeming mutual funds. When we prematurely cash out our funds, we interrupt the magic of compounding—the secret sauce behind investment growth. Compounding is what makes your money work harder for you over time. So, why bid farewell to your funds when you can keep them intact and still access the credit you need?
Now, let’s not forget about the tax implications of mutual fund redemption. For equity schemes, long-term capital gains (LTCGs) above ₹1 lakh are taxed at 10%. If you’ve invested for less than 12 months, brace yourself for a higher tax rate of 15% on the gains. These tax burdens can diminish your overall returns. But fear not! By considering LAMF, you can avoid these tax headaches and hold on to more of your hard-earned money.
Credit cards entice us with appealing cashback offers and flashy marketing gimmicks, tempting us to overspend. However, their interest rates can climb as high as 18-24% per annum or even more! Instead of relying on credit cards, why not harness the power of mutual fund units as a line of credit? LAMF offers a much cheaper alternative, with interest rates typically ranging between a friendlier 9-11% p.a.
Imagine this—your mutual fund units becoming your trusty sidekick, offering an overdraft facility to create a secure line of credit. It’s like having a financial fortress at your disposal.
With LAMF, you can unleash the power of your equity mutual funds, accessing up to 50% of their value. And if you have debt mutual funds in your arsenal, you can tap into up to 80% of their value. Even if you have multiple mutual fund schemes, you can avail credit against all the schemes at the same time. You also can choose particular schemes against which you wish to avail credit. However, in case of tax saver funds (ELSS) you would not be able to avail credit till the fund units crosses the lock-in period of three years. Various fintech companies have joined forces to simplify the process, bidding farewell to unnecessary paperwork and reducing processing time. Within a few clicks, you can have the money you need in your account within hours. Talk about convenience!
Imagine you’re yearning for a dream vacation and need ₹3 lakh. You have two options at hand.
Option 1: Redeeming mutual fund units. Let’s assume that your mutual fund units grow at 10% CAGR (compound annual growth rate) for the next three years, amounting to ₹399,300. Based on this assumption, your kitty has grown by ₹99,300.
Option 2: Lien your mutual fund units and take a loan of ₹3 lakh for 3 years at an interest rate of 10% p.a. Here, your EMI will be ₹9,680 per month, including a total interest of ₹48,486 spread over 3 years. So, the amount repaid, including principal, is ₹348,486.
By choosing option 2 and LAMF, you could end up making ₹50,814 more ( ₹399,300- ₹348,486) compared to redeeming your funds, provided the mutual fund units grow at a 10% CAGR as assumed. That’s more than just pocket change, even if you may have to pay a processing fee of around ₹1,000 for option 2. You also have the option to prepay the loan whenever you wish. While many lenders do not have prepayment charges, some lenders do impose a charge or have a minimum time period clause before prepayment. By unlocking the power of LAMF, you retain ownership of your investments and continue to benefit from their growth potential. You’re not sacrificing your long-term financial goals or bidding farewell to the magic of compounding. It’s like having your cake and eating it too!
So, the next time you’re tempted to redeem your mutual funds or accumulate credit card debt, don’t be a hasty spender. Consider LAMF for a win-win situation—retaining ownership of your investments while enjoying the convenience and cost-effectiveness of a credit line.
Sudip Mandal is VP & head, distributor marketing, DSP Mutual Fund.
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Updated: 14 Aug 2023, 10:27 PM IST