The Common Dilemma: Break FD/Mutual Fund or Take a Loan?
Imagine you have ₹50 lakh parked in a Fixed Deposit or a Mutual Fund. Suddenly, you need a loan of ₹50 lakh for a major expense — maybe a home renovation, business expansion, or even a new property. The instinctive reaction for many is to break the investment and pay cash upfront, avoiding the hassle and interest of a loan. While emotionally satisfying, this might not always be the smartest financial move.
Why? Because your investments are growing — earning compound interest or market-linked returns — while the loan interest is a cost. Breaking your investment means losing out on future growth, potentially costing you more in the long run than the interest you pay on the loan.
Introducing the Systematic Withdrawal Plan (SWP) Strategy
Instead of breaking your FD or Mutual Fund, consider taking the loan and using a Systematic Withdrawal Plan (SWP) to pay your monthly EMIs. An SWP allows you to withdraw a fixed amount from your investment every month. This way, your investment corpus continues to earn returns on the remaining amount, while you use the withdrawals to service your loan.
This approach leverages the power of compounding and the reducing balance nature of loans to optimize your cash flow and wealth creation.
Case Study: ₹50 Lakh Loan and Investment Scenario
Let's analyze a real-world example to understand this better.
| Parameter | Value |
|---|---|
| Loan Amount | ₹50,00,000 |
| Loan Tenure | 20 years |
| Interest Rate on Loan | 8.5% per annum |
| Monthly EMI | ₹43,391 |
| Investment Corpus (FD/MF) | ₹50,00,000 |
In this scenario, your monthly EMI for the ₹50 lakh loan at 8.5% interest over 20 years is approximately ₹43,391.
What Should Your Investment Return to Sustain This Plan?
The critical question is: How much should your Fixed Deposit or Mutual Fund earn annually to support monthly withdrawals of ₹43,391 for 20 years without touching the original corpus upfront?
The answer: about 8.95% per annum.
This means that if your investment earns at least 8.95% yearly, your ₹50 lakh corpus can sustain monthly withdrawals of ₹43,391 for 20 years, perfectly matching your loan tenure and EMI amount.
This is a powerful realization — your money can work for you to pay off your loan without breaking your investment.
Why 8.95%? The Math Behind the Numbers
Let's break down the logic with financial math.
The loan EMI is calculated based on the loan amount, tenure, and interest rate using the standard EMI formula:
EMI = [P × r × (1 + r)^n] / [(1 + r)^n – 1] Where: P = Principal loan amount (₹50,00,000) r = Monthly interest rate (8.5%/12 = 0.7083%) n = Number of monthly installments (20 × 12 = 240)
This gives the EMI of ₹43,391.
Now, for the investment corpus to sustain monthly withdrawals of ₹43,391 for 20 years, it must generate returns that compensate for these withdrawals and inflation.
The withdrawal formula for an investment earning a fixed annual return is:
Withdrawal = P × [r × (1 + r)^n] / [(1 + r)^n – 1] Where: P = Investment corpus (₹50,00,000) r = Monthly return rate (annual return / 12) n = Number of withdrawals (240)
By trial or using financial calculators, the annual return that matches ₹43,391 monthly withdrawal over 20 years from ₹50 lakh is approximately 8.95%.
Why This Strategy Works: The Power of Compounding and Loan Amortization
The key to this strategy is understanding how compounding and loan amortization interplay.
- Compound Interest on Investments: Your FD or Mutual Fund continues to earn interest or returns on the remaining corpus after each withdrawal. This means your money keeps growing, offsetting the withdrawals.
- Reducing Balance Loan Interest: Your loan interest is charged on the outstanding principal, which reduces with every EMI payment. So, your interest burden decreases over time.
- Matching Withdrawal to EMI: By aligning your monthly withdrawals to your EMI amount, you create a cash flow that services the loan without dipping into your principal investment.
This synergy ensures you don't deplete your investment corpus prematurely while servicing your debt.
Real-World Example: Mutual Fund SWP vs. FD Withdrawal
Let's compare two investment types you might use for this strategy:
| Investment Type | Expected Annual Return | Volatility | Liquidity | Tax Implications |
|---|---|---|---|---|
| Fixed Deposit (FD) | 6.5% - 7.5% | Low | High (Premature withdrawal penalties apply) | Interest taxable as income |
| Mutual Fund (Equity/Debt Hybrid) | 8% - 12% (historical average) | Moderate to High | High | Capital gains tax applies |
Interpretation: Mutual Funds generally offer higher returns, which makes them more suitable for this SWP strategy. However, they come with market volatility and tax considerations. Fixed Deposits are safer but offer lower returns, which might require a longer tenure or higher corpus.
Inflation and Its Impact on This Strategy
Inflation erodes the purchasing power of money over time. When you take a loan, your EMI amount remains fixed in nominal terms, but its real value decreases as inflation rises. This means the real burden of your EMIs lessens over the years.
Similarly, your investments ideally should generate returns above inflation to preserve and grow your wealth. For instance, if inflation averages 6%, an 8.95% return on your investment yields a real return of approximately 2.8%.
This positive real return helps sustain your corpus and withdrawals over the loan tenure.
Scenario Analysis: What If Your Investment Returns Differ?
The success of this strategy hinges on your investment returns relative to your loan interest rate and EMI.
| Scenario | Investment Return | Outcome |
|---|---|---|
| Investment Return = Loan Interest Rate (8.5%) | 8.5% | Corpus gradually depletes; withdrawals cover EMI but no growth |
| Investment Return > Loan Interest Rate (e.g., 9.5%) | 9.5% | Corpus grows or sustains; withdrawals cover EMI comfortably |
| Investment Return < Loan Interest Rate (e.g., 7%) | 7% | Corpus depletes faster; may need to break investment or arrange extra funds |
If your investment returns fall below your loan interest rate, this strategy becomes risky, and you may end up eroding your corpus or facing liquidity issues.
Practical Tips to Implement This Strategy Successfully
- Choose the Right Investment: Mutual Funds with a good track record or Fixed Deposits with competitive rates can be used. Equity-oriented mutual funds tend to offer higher returns but come with volatility.
- Match Tenure and Withdrawal Period: Align your SWP tenure with your loan tenure to avoid mismatches in cash flow.
- Monitor Returns Regularly: Keep track of your investment performance and be ready to adjust your withdrawal amount or loan repayment strategy if returns dip.
- Consider Tax Implications: Withdrawals from mutual funds may attract capital gains tax. Factor this into your calculations.
- Emergency Fund: Maintain a separate emergency fund to avoid breaking your investments in case of unexpected expenses.
Story: How Rajesh Used SWP to Manage His Home Loan
Rajesh, a software engineer from Bangalore, had ₹50 lakh in a diversified mutual fund portfolio. He wanted to buy a home and needed a ₹50 lakh home loan at 8.5% interest for 20 years. Instead of liquidating his investments, he took the loan and set up an SWP to withdraw ₹43,500 monthly, matching his EMI.
Over the years, his mutual fund delivered an average annual return of 10%. His corpus not only sustained the withdrawals but also grew, allowing him to build additional wealth while servicing his loan. Rajesh’s disciplined approach and regular monitoring ensured he never had to break his investments prematurely.
Rajesh’s story exemplifies how understanding and applying the SWP strategy can lead to smarter financial decisions.
Comparing Breaking FD vs. Using SWP to Pay EMIs
| Criteria | Breaking FD/Mutual Fund | Using SWP to Pay EMIs |
|---|---|---|
| Immediate Liquidity | Available but corpus depleted | No corpus depletion upfront |
| Compound Growth | Lost once broken | Continues on remaining corpus |
| Interest Cost | No loan interest | Pay loan interest |
| Tax Efficiency | Possible capital gains or interest tax | Withdrawals taxed, but loan interest may be deductible (home loan) |
| Financial Discipline | Less required | High — requires monitoring and discipline |
While breaking your FD or mutual fund gives immediate liquidity and no loan interest cost, it sacrifices future compound growth. Using SWP to pay EMIs preserves your corpus and leverages compounding but requires discipline and careful planning.
Who Should Consider This Strategy?
- Individuals with a sizeable investment corpus in FDs or Mutual Funds.
- Those who want to avoid breaking investments prematurely.
- Borrowers with loans at reasonable interest rates (close to or below expected investment returns).
- Investors comfortable with moderate risk and willing to monitor their portfolio.
- People seeking to optimize tax and cash flow management.
Limitations and Risks to Keep in Mind
No financial strategy is without risks. Here are some to consider:
- Market Volatility: Mutual fund returns are not guaranteed. A market downturn can reduce your corpus and affect your ability to pay EMIs.
- Interest Rate Changes: If your loan has a floating interest rate, increases can raise your EMI, disrupting your withdrawal plan.
- Tax Changes: Changes in tax laws can affect your net returns and withdrawals.
- Discipline Required: You must stick to your SWP plan and avoid impulsive withdrawals.
- Liquidity Needs: Ensure you have an emergency fund separate from this corpus.
How to Get Started: Tools and Resources
To implement this strategy effectively, use financial calculators and apps designed to compare loan EMIs and investment withdrawals. Our LoanVsFD App helps you input your loan and investment details to find the exact return rate needed to sustain your withdrawals.
Additionally, consult with a financial advisor to tailor the plan to your specific situation.
Conclusion: Make Your Money Work Smarter, Not Harder
Taking a loan while keeping your Fixed Deposit or Mutual Fund intact and using a Systematic Withdrawal Plan to pay EMIs is a financially savvy strategy. It harnesses the power of compounding, reduces the need to liquidate investments prematurely, and can help you build wealth even while servicing debt.
Remember, this strategy works best when your investment returns are close to or exceed your loan interest rate, and when you maintain discipline in managing withdrawals and repayments.
So next time you face the choice between breaking your FD or taking a loan, consider the SWP option — let your money work for you.
Want to try this for your own loan amount? Download the Loan versus FD App for smarter financial decisions.
