Loan Against Securities vs Redeeming Mutual Funds: Which Makes More Sense?

Let's say you've accumulated ₹20 lakh in mutual funds over several years. You need ₹4 lakh for a temporary financial requirement, but you would prefer not to redeem your long-term investments.

Depending on the securities you hold and the lender's conditions, you may be able to pledge eligible mutual fund units and borrow against them.

Your investments remain in your name, although the pledged units become security for the loan and are subject to the lender's rights and restrictions. You receive access to an agreed borrowing amount and pay interest and any applicable charges according to the loan terms.

Once you repay the borrowing and fulfil the lender's requirements, the pledge or lien can be released.

The attraction is understandable. You haven't necessarily had to sell investments accumulated over several years, and the money can remain invested towards your financial goals.

But there is an important difference between having investments worth ₹20 lakh and having ₹20 lakh freely available while those investments are pledged.

The lender will determine which securities are acceptable, how much can be borrowed against them and what happens if their value changes.

You also remain responsible for repaying the loan, irrespective of how your investments perform.

That is why LAS should be viewed as a borrowing decision supported by investments, rather than simply another way to withdraw money from your portfolio.

Consider someone who runs a business and has a substantial long-term mutual fund portfolio.

A large payment from a customer is expected in three months, but an important business or household requirement needs to be met immediately. The investor could redeem mutual funds to meet the requirement, even though the money may be needed for only a short period.

Alternatively, a Loan Against Securities might help bridge the temporary gap.

If the expected payment is reasonably dependable, the borrowing is affordable, and the investor understands the collateral risks and loan terms, this could be a sensible option to consider.

The investor gets access to funds without immediately selling long-term investments. Once the expected payment arrives, the loan can be repaid.

This is an example of LAS serving a useful financial purpose. It addresses a short-term liquidity problem without necessarily disrupting the long-term investment plan.

But notice what makes the borrowing potentially sensible.

It's not simply that the investor owns mutual funds. It's that there is a temporary requirement, a credible repayment source and a reason to avoid an immediate redemption.

Now imagine another investor who needs the same ₹5 lakh but has no dependable income or expected payment from which to repay the loan.

The only repayment plan is to sell investments later, hopefully after markets improve.

Would borrowing still solve the problem?

It may simply postpone the redemption while adding interest costs and exposure to a market decline. If the investments fall in value before the loan is repaid, the investor could find themselves in a more difficult situation than before.

The same loan amount can therefore be reasonable for one investor and inappropriate for another.

This is one of the most important risks to understand before taking a Loan Against Securities.

Suppose you pledge mutual funds worth ₹10 lakh and borrow ₹5 lakh against them.

Your loan represents 50% of the initial collateral value. This relationship is called the Loan-to-Value ratio, or LTV.

Now imagine the market falls and those investments are worth ₹8 lakh.

You still owe the lender ₹5 lakh, apart from any accumulated interest or charges. But your borrowing now represents 62.5% of the reduced collateral value.

Depending on the lender's permitted LTV and the loan terms, this change could create a problem.

The lender may ask you to provide additional eligible securities, repay part of the loan or otherwise restore the required margin.

If you cannot meet those requirements, the lender may have the right to sell some of the pledged securities to recover the outstanding amount.

Think about what this means for your long-term investment plan.

You may have taken the loan specifically to avoid selling investments during a temporary financial requirement. But if markets fall sharply and you cannot meet the collateral requirements, those investments could end up being sold at precisely the time you wanted to remain invested.

Borrowing against your portfolio doesn't remove market risk. It introduces a new situation in which a market decline can create an immediate financial obligation.

The investments themselves haven't become more volatile because you borrowed against them. What has changed is your ability to remain invested through that volatility without needing additional cash.

This is why a Loan Against Securities should never be judged only by how much money the lender is willing to offer.

The investor needs to understand how much borrowing is genuinely required, what room exists for market fluctuations and whether additional money would be available if the collateral value declines.

One of the main attractions of LAS is that you can keep long-term investments in place instead of redeeming them.

That can be valuable.

When investments are redeemed, the amount withdrawn no longer participates in any future growth of those investments. Depending on the circumstances, redemption may also involve exit loads or capital-gains taxation.

For an investor with a well-structured portfolio, avoiding an unnecessary redemption may help preserve the continuity of the long-term strategy.

But there's a mistake investors should avoid here.

Keeping investments in the market doesn't mean they will necessarily grow during the period of the loan.

The investments could deliver attractive returns, remain relatively unchanged or decline in value.

Meanwhile, the cost of borrowing continues according to the loan agreement.

For that reason, the decision cannot be reduced to comparing an expected investment return with the interest rate on the loan.

You also need to consider the purpose of the borrowing, how repayment will be funded, the potential for collateral shortfalls and what would happen if the financial requirement lasts longer than expected.

If you have a reliable short-term repayment source, preserving long-term investments may be worthwhile despite the borrowing cost.

If there is no clear repayment plan, keeping the investments untouched may provide psychological comfort without improving your financial position.

Sometimes redeeming an appropriate portion of your investments and avoiding additional debt could be the more sensible choice.

There is another use of LAS that we believe investors should approach very differently.

Suppose an investor has a sizeable mutual fund portfolio and discovers that they can borrow against it at an interest rate that appears lower than the returns they expect from another investment.

The reasoning might sound attractive: why not borrow against the existing portfolio, invest the borrowed money elsewhere and earn the difference?

On paper, this can look like a clever way to generate additional wealth.

But consider what the investor is actually doing.

The existing investments are now pledged as collateral, and the investor has taken on a loan that must be serviced regardless of market conditions. The borrowed money is then exposed to another investment whose returns are uncertain.

If markets perform well, the investor may benefit. But if the investments decline, there could be losses on the new investments alongside pressure on the pledged portfolio.

The lender's collateral requirements remain in force even when market conditions are unfavourable.

What began as a strategy to earn additional returns could create a situation in which the investor has to find more money, repay a loan or sell securities during a market decline.

This is leverage, and it can magnify the consequences of an incorrect investment decision.

At FinEdge, we strongly discourage borrowing against an investment portfolio merely to make additional investments or to pursue an expected return difference over the loan interest rate.

A loan's interest cost is an obligation. An investment's future return is an expectation. Treating the difference as something that can reliably be earned is a poor basis for taking additional risk.

There is also a regulatory dimension: depending on the lender and facility, the permitted use of loans against securities may be restricted.

But our objection is more fundamental than the terms of a particular loan.

When the primary reason for borrowing is the hope of earning higher investment returns, the investor may be allowing the desire for additional returns to override a sensible assessment of risk.

That's very different from using borrowing responsibly to meet a genuine short-term financial requirement.

Let's look at another situation.

An investor has been accumulating mutual funds for their child's higher education. College admission is approaching, and ₹8 lakh needs to be paid.

The investment portfolio was built specifically to support this requirement.

Would taking a loan against those mutual funds make more sense than redeeming the required amount?

Not necessarily.

If the money was invested for education and the financial goal has arrived, using the investment for its intended purpose may be exactly the right outcome.

Borrowing merely to avoid redeeming could turn a planned financial requirement into a debt obligation.

The investor would then need to explain how and when that debt would be repaid, and why taking on the additional obligation improves the financial position.

The answer could be different if the investor expects a dependable payment shortly, needs temporary flexibility or has another compelling reason to preserve the investments.

But having the option to borrow doesn't mean borrowing is necessary.

The same principle applies to other financial requirements.

If an investor needs money permanently, or would struggle to repay a loan without disturbing essential household finances, redemption may be more appropriate.

The decision should also consider which investments are available, their liquidity, tax and exit implications, and what the withdrawal would mean for the remaining financial goals.

An investor might not need to redeem the entire investment. A partial withdrawal could provide sufficient money while retaining the balance for future requirements.

The objective is to identify a funding decision that serves the overall financial situation, rather than automatically choosing the option that keeps the largest amount invested.

Let's return to the example of an investor who needs ₹5 lakh.

Before deciding to borrow, it helps to have a clear conversation about the financial requirement.

How soon is the money needed, and is the requirement temporary or permanent? If you borrow, which income or expected payment will repay the loan, and how dependable is that repayment source?

You also need to understand what the borrowing will cost. Interest, processing charges, renewal conditions and the nature of the credit facility can all affect the decision.

Then there is the portfolio itself.

Which investments would be pledged? Are they intended for long-term goals? What happens to their accessibility while pledged, and how much additional collateral or repayment might be required if markets fall?

Finally, consider the alternative. If you redeemed an appropriate amount instead, what financial goals would be affected, and what costs might be involved?

These questions are more useful than simply asking whether the loan interest rate is attractive.

In some situations, borrowing may provide valuable flexibility without significantly affecting the investor's longer-term financial security.

In others, avoiding debt may be worth more than the possibility of keeping additional money invested.

At FinEdge, we believe investment decisions need to be understood in the context of the investor's life, not simply through the products available.

The same applies when an investor needs money.

The first question isn't whether a Loan Against Securities is available or what interest rate a lender is offering. We need to understand the financial requirement, its urgency, the investor's cash-flow position and the impact of different choices on existing goals.

Sometimes a temporary need for money can be addressed through borrowing without disturbing investments intended for the long term.

At other times, redeeming an appropriate amount may leave the investor in a stronger financial position because it avoids unnecessary debt and repayment pressure.

The Investment Manager's role is to help the investor understand how the available choices affect the investment portfolio and financial goals, while the borrowing facility itself remains subject to the lender's terms and eligibility requirements.

What we would strongly discourage is treating a Loan Against Securities as a way to increase investment exposure or pursue higher returns through borrowed money.

Investing already involves uncertainty. Introducing a loan simply to chase additional returns can make the consequences of a market decline considerably harder to manage.

A well-designed investment plan should create greater financial flexibility and help an investor make better decisions over time. Borrowing can occasionally support that objective, but it shouldn't become a reason to take risks the original plan didn't require.

A Loan Against Securities is most useful when it helps solve a genuine short-term money requirement without creating a larger financial problem.

If you need money and are considering redeeming mutual funds or borrowing against them, start by understanding what each choice means for your cash flows, investments and financial goals.

The right decision isn't necessarily the one that keeps you fully invested. It's the one that leaves your overall financial position better aligned with what you need to achieve.