A loan or liquidating your assets? What to do when you need cash?

When you need money for some urgent, large expense, and you don’t have it, the only option is to borrow.

But what if you have it in your investments? Should you liquidate them? Or should you take a loan?

While the intuitive answer might be to avoid borrowing, more so when you have some savings up your sleeves, a lot other factors are at play as well.

It’s not the intention of this piece to nudge you to take loans. Being loan-free  is the best scenario. But people have different requirements and are in different circumstances. Let’ take a look.

Math of loan rates vs investment returns

The very first thing to consider is plain mathematics. If you need money and you have a fixed deposit (FD) giving 5 percent, taking a personal loan at 12-15 percent isn’t wise. In such a case, just use your FD.

But what if you have invested the money in assets which can potentially give higher returns? Let’s say, equity, which can give 10-12 percent.

Does it make sense to liquidate such investments instead of taking a loan?

What needs to be understood here is that the potential for high returns is not the same as the promise of high returns. Equities can deliver an average 10-12 percent return in the long term, but there is no guarantee. At least, you won’t get it year after year.

So while you take a loan and your investments do well, it would look like a good decision. But if markets fall after you take the loan, it would look stupid.

Type of money requirement vs type of asset

How urgent and large is your money requirement? And how large is your investment/asset you are considering liquidating?

Suppose you urgently need Rs 10 lakh for a family emergency but the only asset you have is a piece of land worth Rs 15 lakh? In that case, you might have to take a loan as selling land is a slow process.

On the other hand, if you have a smaller requirement like, say, Rs 4 lakh, and you have a similar amount in a bank FD, using the FD is advisable unless it’s earmarked for some other goal or expense in the near term.

In cases where the requirement is too small (say a few lakh rupees) and the asset available is too large (a multi-crore property), you cannot sell the asset. So a loan is the only option. But if the investment is in something like a mutual fund (MF), you can consider a partial withdrawal.

But while opting for liquidation of investments, keep in mind the tax implications. Generally, the sale of any asset leads to capital gains, which are taxed accordingly. So that should be kept in mind before selling.

You may also not want to liquidate investments you will not be able to invest back freely if you want to, later. An example is PPF.

The good old PPF allows partial withdrawal from the seventh year onwards. Let’s say you withdrew Rs 6 lakh. Now, after a year, if you have a surplus of Rs 6 lakh, can you replenish the PPF? That is not possible as you cannot invest more than Rs 1.5 lakh in PPF in a given year. So, rules related to reinvestment also need to be kept in mind before liquidating your assets.

Emergency fund can come in handy

You have heard this many times before: always keep an emergency fund for unexpected, unplanned, and uninsured events. And rightly so. If you have such emergencies, you can easily dip into the emergency fund which was specifically installed for this very purpose.

Having an emergency fund also protects your long-term investments from such unexpected withdrawals and breaking the compounding effect.

If you don’t have an emergency buffer in place, and if the emergency comes at a time when markets are down, you will be forced to book losses to fund your emergency. And dipping into long-term investments also upsets your financial goal planning.

To summarise, if it’s a really critical emergency, you got to do what you got to do. In case of emergencies, taking an online personal loan might be the quickest option. So, one can go for it first and repay the loan by liquidating investments later. But in most questions around liquidating investments vs taking a loan, it is better to do an objective cost-benefit analysis before you decide whether you should liquidate your investments or go for a loan.