Cash purchase and incentives

[jsphlynch]

Nothing, assuming sufficient reserves. Definitely don't play with money you don't have--using various tools to manage cashflow and liquidity is not the same thing as speculating on overleveraged margin. So what can you do if you lose your job and have a car loan? Well, if you have sufficient cash reserves (you must, you were going to pay cash, right?) you simply pay the monthly out of the reserves. In this case you're probably better off having a known monthly payment to budget for plus a pot of money instead of having no payment and no money because you spent all your cash on the car. That gives you time to figure out what to do, instead of needing to panic-sell the car to buy food or whatever.

If you're buying stocks with borrowed money, you're playing with money you don't have. Consider the following hypothetical situation:

I’ve scrimped and saved, and now have $37,000 (in addition to an emergency fund) to buy my dream truck. Little do I know that the auto bubble is going to pop when the economy tanks a year later. Choose your own adventure:

Scenario A: I pay cash and own the truck outright. Every month for the next year, instead of making a car payment, I put $440 into stocks, which are frustratingly flat over that year. Economy tanks and I lose my job. I have no car payment, so I make it through on my emergency fund no problem. I keep my truck, which I love. In the current market it’s only worth $20k, but I’m ok with that because I have no plans to sell it. The value of my year’s worth of investing is down to ~$3k, but I don’t need to tap into my investment. As the economy recovers, I get a new job and commute in my Ranger. Meanwhile, the stocks have made up their losses, so I once again have over $5k in the investment account and no debt. With no monthly truck payments, I re-establish financial security by saving $440/month to rebuild my emergency fund.

Scenario B: I take their offer for 84 months at 0% because it’s “free” money. I have a monthly payment of $440, which easily fits into my budget (which I stick to religiously). With the payment, I don’t have room in the budget to build savings, but instead I invest the $37,000 cash I was going to pay for the truck into a diversified stock portfolio, which stays flat for the next year. Economy tanks and I lose my job. I can meet most of my basic expenses with my emergency fund, but not the car payment. I still owe a little over $31k on the truck, which is now only worth $20k. To avoid defaulting on the payments, I sell my stocks, which are now worth $22k, and the truck, using the stock sale to pay the balance of the truck loan and buy a 2011 F-150. As the economy recovers, I get a new job and commute in my aging F-150. I have no savings, but I have no car payment so I start saving $440 per month to rebuild my emergency fund.

Scenario C: As in “B” I take the finance offer and invest my cash. However, when the economy tanks, I really want to keep the truck, so I start selling off my stocks (now worth $22k after the crash) to be able to keep making the monthly payments. A year later, my stocks are now down to $16,700 due to the payments, when the economy makes a miraculous overnight recovery, with the stock market exactly making up its losses from the year prior, bringing the value of my remaining investment up to just under $28k. I get to commute to my new job in my beloved Ranger, which I still owe over $26k on. However, I’ve used up my emergency fund, and don’t have room in my budget to rebuild it because of the car payment.

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[VAMike]

If you're buying stocks with borrowed money, you're playing with money you don't have

No, you're still understanding it wrong. An emergency fund, the cash allocation in an investment portfolio, money tied up in long term investments, extra money that's sitting around in a savings account, and the money spent on things like trucks are all separate things but all part of a complete portfolio. If someone doesn't have have the cash reserves to weather a downturn this is all moot and they probably shouldn't be buying a fancy new truck with or without a loan. If someone does have sufficient reserves to weather a downturn, then this is simply a conversation about how to allocate assets. There's nothing emotional in here, it's just numbers on a spreadsheet.

Scenario B: I take their offer for 84 months at 0% because it’s “free” money. I have a monthly payment of $440, which easily fits into my budget (which I stick to religiously). With the payment, I don’t have room in the budget to build savings, but instead I invest the $37,000 cash I was going to pay for the truck into a diversified stock portfolio, which stays flat for the next year. Economy tanks and I lose my job. I can meet most of my basic expenses with my emergency fund, but not the car payment.

Sounds like you didn't have enough of a reserve fund and/or simply forgot to account for the loan payment.

However, I’ve used up my emergency fund, and don’t have room in my budget to rebuild it because of the car payment.

Sounds like you bought more truck than you can afford.

Scenario D: You use the capital that's not tied up in the truck to buy into the market while it's down, and live off your emergency fund. At the end of the ride the $37k is worth what, $50k (I didn't bother doing the math on your scenarios to figure out your assumptions)? You can take some of the profit to replenish the emergency fund.

A loan is just a tool, to use in a way that makes sense, factoring in risk tolerance, asset allocations, etc. It's not inherently good or bad, despite this weird moral righteousness you find on the internet. And it's key to understand that money is fungible--you're not really taking a specific dollar and using it for one thing or another, you're just squishing numbers around. "Invest the money" is shorthand for "balance the liability against your assets, weighing the expected return of your overall portfolio against the interest on the debt". You don't either put $x into a truck or $x into bonds or $x into stocks or $x into gold. You're really allocating $x to buy the truck outright by reducing the allocations across everything else by $x (assuming you have a target asset allocation and stick to it); conversely if you get the loan you don't create $x and put it in a special box--you simply have a new liability balanced against your assets, a timeline for reducing the liability to zero with planned transfers from assets, and slightly more in the asset column right now than if you paid cash. Scenarios A-D shouldn't really exist as stated: the loan shouldn't change your asset allocation, you shouldn't have exactly that much money either in or out of a specific investment. Instead, you should have some idea of what portion of your portfolio to have in stocks, bonds, cash, etc. (This is cash unrelated to the emergency reserve.) Paying cash vs taking the loan impacts the overall amount allocated, not the proportional allocations, so how you do in any of the scenarios has more to do with how much you have and how you allocate it, and less to do with the specific amount in a loan (or not). Put another way, the issue at question is whether you can do something with the money that's worth more than the $x the loan will cost. If the answer is no, that you have no idea what you'd do with the money, then paying cash probably makes sense. If the answer is that you'll pay $x and expect to make $x+y, then maybe it makes sense to do so. Of course there's a risk that you won't actually make $x+y, and you factor that into the calculation and make sure that $y is worth the risk, based on your personal tolerance. And of course you want some reserves and some hedges because sometimes investments work out and sometimes they don't. It may well turn out that the expected return vs your tolerance make this not worth doing--but that should be an informed decision based on evaluating the numbers, not simple repetition of a mantra that debt is bad and money under the mattress is good.

The danger in your scenarios doesn't come from a loan, it comes from being one truck away from insolvency and buying the truck anyway.

 

[Leftcoast]

The reason I'm against not paying cash (if you can afford it) is that the typical member on this board isn't financially savvy. I'm not going to encourage them to stick their neck out even further by financing and putting all of their money with a WSB mindframe or following the latest fund by Kathie Wood.
Sure a focused educated individual could make a few percent over time on the trade. That's not the debate. It's introducing the arbitrage to the neophyte.
Bulls make money, bears make money, pigs get slaughtered.

 

[jsphlynch]

The danger in your scenarios doesn't come from a loan, it comes from being one truck away from insolvency and buying the truck anyway.

Despite being in bold, this is wrong. The fellow in my little story is not one truck away from insolvency. He can afford the truck and weather the economic storm just fine (he does so in Scenario A) if he pays cash. The danger comes from getting all starry-eyed seeing that the S&P rose 40% in past two years, taking your advice from post 10, buying the truck, but also taking out a loan so he can have both the truck and the $37k, and thus invest the latter in the hopes of getting a piece of these incredible returns.

A loan is just a tool...

Agreed. But always use the right tool for the job. Debt is not a good tool for stock investments.

You use the capital that's not tied up in the truck to buy into the market while it's down

This is called "timing the market". In principle it sounds great. In reality, the market is not predicable enough for it to work, so few people come out ahead with it (and most of those people only come out ahead because they get profits from selling books on late-night TV and AM radio about how to time the market).

Sounds like you didn't have enough of a reserve fund and/or simply forgot to account for the loan payment.

Sounds like you bought more truck than you can afford.

No, this fellow can afford the truck, and has plenty of reserve fund. He bought more "free money" than he could afford via the no-interest loan. With no loan (as in scenario A), he doesn't have to account for the loan payment.

If someone doesn't have have the cash reserves to weather a downturn this is all moot and they probably shouldn't be buying a fancy new truck with or without a loan.

Agree 100%

I didn't bother doing the math on your scenarios to figure out your assumptions

Assumptions:
-Truck costs exactly $37k OTD.
-Financing is 84 months at 0%, no fees.
-For simplicity, no annual taxes or insurance
-Stock investments track the average market
-Simplistic recession: For the first 12 months, the market stays perfectly flat. At that point, prices drop 40% overnight, then stay flat for 12 more months, then rise overnight to exactly match what they were pre-recession.

 

[VAMike]

Despite being in bold, this is wrong. The fellow in my little story is not one truck away from insolvency. He can afford the truck and weather the economic storm just fine (he does so in Scenario A) if he pays cash.

You came up with a carefully contrived scenario where in one case the strawman is panic selling assets over a $5k difference in cashflow over a year and act as though that's some sort of gospel truth. He can afford the truck and weather the economic storm just fine without paying cash, you just seem unwilling to accept that's a possibility. Are there scenarios where assets will decline in value? Sure. That's the part about factoring in risk and determining your tolerance. If you're really the sort that would panic if things are down a bit, I guess that means your risk tolerance is so low that you shouldn't put your money anywhere except FDIC insured bank accounts. But if you're planning over the long term, short term volatility is expected, and not a big deal. Nothing goes up forever, that's why you diversify. The logical conclusion of the "all cash all the time" mindset is to keep a pile of money under the bed, and the one thing that's sure to happen in that scenario is that the value of the pile under the bed will decrease over time due to inflation.

The danger comes from getting all starry-eyed seeing that the S&P rose 40% in past two years, taking your advice from post 10, buying the truck, but also taking out a loan so he can have both the truck and the $37k, and thus invest the latter in the hopes of getting a piece of these incredible returns.

Yes, you keep repeating stuff like that. Which cult are you coming from? Ramsey? I guess you didn't actually read anything I wrote. Nobody's talking about "starry-eyed" margin speculation except you.

This is called "timing the market". In principle it sounds great. In reality, the market is not predicable enough for it to work, so few people come out ahead with it (and most of those people only come out ahead because they get profits from selling books on late-night TV and AM radio about how to time the market).

No, what I wrote it isn't timing the market. If you set targets and execute based on your targets you're not playing games with market timing. Of course market timing works both ways--when do you liquidate assets to buy something with cash? The loan is effectively spreading the cost over time. You pay a service charge for that and you can decide if the cost is worth the benefit. The alternative is to increase your cash allocation, which has its own risks. Again, of course there are scenarios where your portfolio will decrease in value--but if you've made sure you have enough reserves that's not a big deal over time. There are no scenarios (including the all cash scenario) which involve no risk. The important thing is to manage risks over the long term and (like it or not) using credit effectively can be a part of that.

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