How to manage debt and build wealth simultaneously

Mastering the Art of Debt Repayment and Wealth Building

We are living in times when debt has become cheaper and more easily accessible to everyone. As a result, people have increasingly come to rely heavily on borrowing. The traditional concept of wealth creation—earning, saving, and investing diligently—has undergone a drastic transformation due to the availability of easy credit.

The debt level in India has been rising consistently and, as of June 2024, the Reserve Bank of India (RBI) reported that dues outstanding from credit card holders reached an all-time high of ?2.7 lakh crore. Personal loans have also been on the rise, and the trend of making larger purchases through credit cards has become common. Furthermore, the availability of EMI options on credit cards has significantly contributed to an increase in the default rates among borrowers.

Today, people often buy expensive items on credit with the intention of repaying the amount in instalments. However, this approach frequently leads to them paying far more in interest than the principal amount itself. On average, banks charge an interest rate of around 3% to 3.5% per month on credit card outstanding amounts, which translates to an annualized interest rate of approximately 36% to 42%. Such high- interest costs result in a substantial reduction in a consumer's disposable income, with a major portion being diverted towards debt repayments.

And this issue is not confined to credit cards alone. Other forms of borrowing such as home loans, car loans, personal loans, education loans, and loans taken for weddings and vacations have further impeded the process of wealth creation in the economy.

In this blog, we will discuss some simple but crucial steps that can help you manage your debt responsibly while simultaneously working toward building wealth:

Step 1: Credit Utilization

One of the key principles of maintaining financial health is proper credit utilization. It is advisable never to spend more than 40% of your total credit card limit. Your credit score, which determines your future loan eligibility and borrowing costs, is largely influenced by your credit utilization ratio—how much credit you have used compared to the credit sanctioned to you. A higher utilization ratio negatively impacts your credit score and also adds unnecessary debt burden. Maintaining a low utilization ratio not only preserves your credit health but also keeps your monthly repayments manageable.

Step 2: Averaging Returns

To counter the cost of debt, you should invest in instruments that help you generate returns comparable to, or higher than, the interest rate you are paying. Allocating funds to flexi-cap mutual funds or Index Exchange Traded Funds (ETFs) can offer average annual returns of around 7% to 8%. Although these investments carry market risks, they can help you grow your money over time and cushion the impact of debt-related expenses.

Step 3: Investing Effectively

While it is important to seek higher returns, it is equally important to manage investment risks. Do not invest all your money in a single asset class. A well- diversified portfolio is key to balancing risk and return. A good strategy is the 40/40/20 rule, allocate 40% to equity, 40% to debt, and the remaining 20% to liquid assets. Debt instruments will provide regular cash flows, while equity can offer higher long-term returns, and liquid assets will ensure that you have immediate access to funds in case of emergencies. Diversification reduces risk and increases the stability of your portfolio, ensuring consistent wealth creation over time.

Step 4: Debt Management

Another critical aspect of financial management is controlling the number of active loans. Taking on multiple debts simultaneously increases the risk of financial stress and bankruptcy, even if your income is high. People juggling many loans often end up saving very little, as a significant portion of their income goes into debt servicing. It is advisable to complete the repayment of one loan before taking up another. This disciplined approach allows you to maintain a manageable EMI burden, stay creditworthy, and avoid unnecessary financial stress. Meanwhile, continue investing small amounts regularly to build a corpus that can hedge against your liabilities.

Managing debt while building wealth may seem challenging, but it is absolutely achievable with a structured and disciplined approach. The key lies in smart credit usage, strategic investing, and efficient debt management. By limiting credit utilization, diversifying investments, and avoiding the trap of multiple simultaneous debts, you can strike a healthy balance between liabilities and asset creation.

Remember, wealth building is a gradual process that demands patience, discipline, and foresight. When you learn to manage debt wisely, it transforms from being a burden into a tool that can actually assist in creating sustainable long-term wealth.