Should you pledge gold to invest in equities?

What looks like an easy arbitrage — borrowing at 8.5 percent and investing at 12 percent — is not so clear-cut. The transaction may work out in case equities give phenomenal returns, but one cannot go with such assumptions.

Nita’s banker has been urging her to put her passive gold assets to use. The banker suggested she take a loan against her gold jewellery, coins, etc., and invest that in equity markets. According to the banker, this will help animate her passive assets and multiply her wealth.

With equity markets on a roll, many investors like Nita are considering taking a loan against their gold, and investing the amount in equities.

The math

Assume Nita takes Rs 30 lakh loan at 8.5 percent interest per annum (p.a.), which she repays in a year. The EMI works out to Rs 2,61,659 per month. Now assume, this Rs 30 lakh is invested in a Nifty 50 index fund for 10 years, with an assumed ROI of 12 percent p.a. At the end of 10 years, the value of the investment would be Rs 91,62,633, taking into account the interest paid in the first year on the loan.

Since Nita has the liquidity, instead of taking a loan, if she invests the amount in the same Nifty 50 Index fund for 10 years, she will end up with Rs 91,95,316.

Clearly, there doesn’t seem to be much point in investing by taking a loan.

Is 12 percent better than 8 percent?

When equity markets are doing well, investors tend to maximize investments in equity by taking loans, or moving from debt to equity. But equity returns are not linear and equities may have long periods of drawdowns. Will investors continue to hold on to their equity investments during downturns? Most likely not, given that only 50 percent of equity SIPs are held for more than two years. Even when markets are doing well, investors are constantly chasing the best performing fund and do not stick to a simple index fund.

The need for action intensifies once one has taken a loan. But there is no guarantee that the investment will work out, and going by past data, churning portfolios doesn’t produce better returns but increases costs and risks. Thus, what looks like an easy arbitrage — borrowing at 8.5 percent and investing at 12 percent — is not so clear-cut. The transaction may work out in case equities give phenomenal returns (above the predicted average), but one cannot go with such assumptions.

Also, is the potential gain really worth the risk of taking on debt? In Nita’s case, she had the funds to pay the EMI, but imagine situations where the income from the investment is needed to repay the EMI. Certainly, volatile market-linked instruments like equities cannot guarantee returns.

Instead of focussing on such small gains, investors should check if they are even beating inflation on their overall portfolio. Most households have less than 10 percent of their financial assets in inflation-beating assets, and a change there can lead to a meaningful increase in their wealth. Even within equities, investors can reduce risk and probably stabilise returns by moving from F&O or concentrated stock portfolios, to diversified equity mutual funds.

Remember disciplined investing leads to long-term success. Do not get swayed by “get-rich-quick” strategies.