It’s the first day of the month, and Shiva’s salary just got credited to his bank account. Earlier that amount would vanish by lunch on the same day because of Shiva’s huge credit card bills due to large EMI payments. Don’t get him wrong, he is not a shopaholic or someone who likes buying the highest priced item on the shelf. He is actually a smart consumer, buying only the product that he really needs after months of research.
A couple of years back, he needed a new phone. As usual, he started his research by going through the reviews of various models and visiting different vendors for the best deal. After diligent research of six months, he finally bought an iPhone on EMI. As expected, his Credit Card bill for the next month inflated and consumed a major chunk of his salary. That’s when he realized that he might be a rational consumer, but moneywise he is not smart.
While having dinner with his friends, Shiva discussed his EMI problem and how stressful it is for him to deal with it. That’s where he got introduced to a new concept of ‘Reverse EMI’. Instead of paying for the product after purchase via EMI, he can start investing a fixed amount of money into a mutual fund for the same period before the purchase, thereby creating a reverse EMI. By initiating the investment way ahead, Shiva thought that he could- (a) get sufficient time for product research; (b) postpone the payments during months with tight liquidity, and (c) generate good returns from the investment, effectively reducing the product cost.
It’s January 1st, 2021 and Shiva is planning to buy a new phone later in the year. Based on his last purchase, he expects to spend around ₹ 1 lakh for this. He wants to buy the phone in October, and accordingly decides to invest ₹ 10 k every first day of the month. He invests this amount in a NIFTY based fund (a fund which tracks NIFTY 50 index) on 1st Jan itself and is committed to do this every month.
It’s 1st April, 2021, and Shiva has been diligently investing ₹ 10 k for the past three months. He is curious to know how his past investment is doing so far. Shiva feels delighted to know that his investment of ₹ 30 k (10k for 3 months) is now worth ₹ 31,234, giving him a profit of ₹ 1,234. Great, so he sticks to his plan till 1st October sticks to his plan of adding instalment each month. When he withdraws his investment, he finds out that it’s worth ₹ 1,14,910. Wonderful, he uses ₹ 1 lakh to buy the new phone and keeps the ₹ 14k as bonus. The effective cost for Shiva: ₹ 86 k = ₹ 1 lakh he saved; minus ₹ 14 k he still has in his account. That’s equivalent of getting a discount of ₹ 14k.
Comparing the EMI and Reverse EMI process:
- In EMI, Shiva is obligated to pay the EMI no matter how his liquidity is. In reverse EMI, he can easily postpone his investment/purchase in case he is running short of surplus cash.
- The obligation created constant stress for Shiva, as missing a payment would incur high charges from the Credit Card company and would also impact his credit score. In reverse EMI, there is no obligation, and Shiva remains stress free.
- In EMI, Shiva paid ₹ 1 lakh for the phone, but in reverse EMI, he got an effective discount of ₹ 14 k. That’s unbelievable to his friends and Shiva gets appreciated for being a smart customer.
Shiva was a smart customer earlier; now he is also smart money planner.
Note: This is a fictional story to demonstrate benefits of implementing reverse EMI. The money movements however are based on actual market movements during the said dates.
Hitesh Gulati, CFA 