scorecardresearchEmergency Funds: Should you redeem your securities or borrow; What is a more feasible option?

Emergency Funds: Should you redeem your securities or borrow; What is a more feasible option?

Updated: 08 Sep 2022, 05:00 PM IST
TL;DR.
Let’s quickly compare borrowing vs redeeming and how investors can safeguard their investments and their long-term goals while meeting their short- term need of money. Below are certain scenarios where borrowing against the securities can be a better option
Should you redeem or should you borrow for short-term requirements?

Should you redeem or should you borrow for short-term requirements?

Most investors invest with long-term goals and are willing to stick by them. However, certain situations make it difficult to stay invested. One is the volatility in the markets and the other is when there is a need for money that you have not planned or foreseen. For first, you can prepare yourself to be patient and confident about your investment strategy by training yourself.

However, for the second situation, most investors are not prepared and redemption seems to be the only choice. What if someone tells you there is a better option than redeeming your investments in these unexpected situations? Availing of an overdraft facility through loan against securities prepares you to take care of your short-term need of money without redeeming your long termlong-term investments.

Let’s quickly compare borrowing vs redeeming and how investors can safeguard their investments and their long-term goals while meeting their short-term need of money. Below are certain scenarios where borrowing against the securities can be a better option:

Investments are negative

There can be a situation wherein you need money and your investments can be negative or overall markets may not be doing well. This would be a wrong time to redeem your investments. However, the need for money cannot be postponed, so one can actually take a loan against the securities instead of redeeming them. This saves investors from turning unrealized losses into realised losses.

Urgency of funds required

Often, we see people needing funds at the last minute. It can be due to an emergency or an unexpected payment, an opportunity with a very short deadline or any scenario wherein someone needs funds at the last moment. In such cases, investment redemptions are out of the question. Ordinarily, investment redemptions, be it mutual funds or shares, takes around 2 days or more to receive the funds and if it’s a weekend, the timeline stretches further. With digital growth in the financial space, one can take a secured loan against investments instantly.

Redeeming an investment with potential

Some of the investments have real potential and all it needs is time and some of the investments are doing really well and have a further potential of doing even better. If in such a scenario there is an urgent need for funds for the short term, it is very difficult for an investor to make a redemption call. One can safeguard these investments by taking a loan against the investments instead of redeeming them.

Entry to investment is restricted

There are few investment options where fresh investments are restricted for various reasons. For example, international mutual fund schemes stopped taking fresh investments due to RBI regulations. Now if you already hold such investments where entry is restricted, you will want to continue to hold such investments. Especially as re-entry to the investment may not be possible. In need of funds, one can lien such funds and avail of a loan instead of redeeming them.

Taxation & exit load

Taxation & exit load are costs that most investors fail to consider. Investments you redeem attract a capital gain tax if you have made gains on that investment. For a short-term requirement, if you plan to redeem your investment, cover the need for funds and plan to reinvest later then it might seem it has not cost you, but you actually have incurred a cost in terms of taxation and exit load in some cases. Instead, you can take a loan against security and cover the cost and make repayments when ready.

However, one should be aware of scenarios where one should go ahead and redeem investments instead of borrowing. Redemption in these cases may be beneficial.

Goal is realised

The goal for which an investment was made is achieved. In such cases, it is ideal to redeem and complete the goal instead of staying invested. In a volatile situation, the investment value can come down and extend the time to achieve the goal.

Short-term investments

If you have invested for the short-term to manage business finances or as emergency funds, then you should utilise them when in need. The golden rule is for short-term investments to be used for short-term needs and long-term for long-term needs.

Corrective action on bad investments

If an investment underperforms consistently and there is no clear future visible to the investment, then it is better to take corrective action and redeem the investment instead of playing the waiting game.

The bottom line is to carry on with the investments as per the goals and utilise the long-term investments to avail of loans to take care of short-term funds requirements.

Most HNI investors often use loans against securities for business financing instead of selling assets. Some of the ultra-HNIs also use loans against securities for raising liquidity. Alibaba co-founders Jack Ma and Cai Chongxin have pledged large quantities of their Alibaba shares since 2014 in exchange for huge loans. In 2021, Elon Musk, co-founder and CEO of Tesla pledged his Tesla shares for lines of credit to cash out money from his pocket.

Availing a loan against securities is a great way of raising liquidity. It allows customers to stay invested, can provide funds instantly, has more repayment flexibility than a personal loan and credit cards, and is more economical than unsecured loans.

Depending on the situation one should take wise & more calculated decisions when it is about managing liquidity for short-term funds requirements.

Krishna Kanhaiya is the Chief Executive Officer at Mirae Asset Financial Services, NBFC arm of Mirae Asset Group
 

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First Published: 08 Sep 2022, 05:00 PM IST