Clements on CNBC - invest 7 year new auto loan proceeds into market

[donfairplay]

This was on CNBC a few months ago. This isn't about a car purchase, more of an "arbitrage" (if we can call it that) situation.

http://video.cnbc.com/gallery/?video=3000359186

Jonathan Clements suggests taking out a 7 year new car loan at 3 to 4% and using the proceeds to buy stocks or stock funds. He also suggests not placing the funds into bonds/treasuries/a savings account.

Obviously this isn't academic risk-free arbitrage, but Clements calls it a reasonable trade-off. Phil LeBeau and a few of the CNBC talking heads objected.

I couldn't do this. What say the bogleheads?

[Aptenodytes]

It has to be more compelling than that to make me watch a video, so I'll just rely on your summary. I am guessing he is referring to a circumstance where you have a choice to pay cash for a car, finance it short-term at a low rate, or finance it long-term at a high rate. As opposed to buying cars you don't need on credit and warehousing them.

You can break the thought process into two bits: finance or not; and finance at longest possible term or lowest possible rate.

In facing such decisions you are acting as your family's CFO. The car is a capital asset that is easily collateralized and therefore capably of being efficiently financed. Your Armani suit may last longer than your Infinity, but it isn't easily collateralized. It is popular here to call cars consumption items, but that's factually not the way a CFO would treat it. You want to look at the opportunity cost of your finance capital; if paying cash for the car is the best possible use of such capital, that's what you do; if there's a more productive use for the capital, you finance the car if the interest is under the expected marginal return for the best alternative use. Risk and liquidity come into play too.

In the present environment the choice to finance seems quite defensible, though that doesn't mean that people who pay cash are making mistakes. You look at the whole picture and make the right choice for your own circumstances. I paid cash for a used car 4 years ago, but I financed my wife's Accord at 0.74% interest two years ago and now that the used car is being passed to my son, I'm financing a Volt at 0.99%.

To go for the longest possible term as opposed to lowest practical rate, you have to be much more risk accepting than to simply opt for financing. I could see making a case for almost all new car purchasers to finance, given that expected investment returns for almost everybody are above the lowest rates available. But to get a seven-year loan at the price of a quadrupling of interest rates, that doesn't seem like a sound bet under any circumstances other than the one where you have some magical ability to count on beating a 4% return in your portfolio. I'm OK saying I expect to beat 0.75 or 0.99 (not guarantee it, but expect it), but not beating 4%.

So he's half right and all wrong.

[edge]

Seems really dumb

[ryman554]

This was on CNBC a few months ago. This isn't about a car purchase, more of an "arbitrage" (if we can call it that) situation.

http://video.cnbc.com/gallery/?video=3000359186

Jonathan Clements suggests taking out a 7 year new car loan at 3 to 4% and using the proceeds to buy stocks or stock funds. He also suggests not placing the funds into bonds/treasuries/a savings account.

Obviously this isn't academic risk-free arbitrage, but Clements calls it a reasonable trade-off. Phil LeBeau and a few of the CNBC talking heads objected.

I couldn't do this. What say the bogleheads?

I say this is a tangible sign of an equity bubble.

[TradingPlaces]

I say this is a tangible sign of an equity bubble.

I respectfully disagree. Even Shiller, who is the world's expert on bubbles, acknowledges that we are not in a bubble (not yet).

This is just a sign of rather poor thinking.

Here are the cons:

- 3/4% too high,
- interest not tax-deductible.

If you are going to do this, do it with a mortgage, taken at a much lower interest rate, preferably below 3%, and preferably in a situation where the full interest amount will be federally tax-deductible, at a marginal rate of 20-some or 30-some percent.

[ryman554]

I say this is a tangible sign of an equity bubble.

I respectfully disagree. Even Shiller, who is the world's expert on bubbles, acknowledges that we are not in a bubble (not yet).

This is just a sign of rather poor thinking.

Here are the cons:

- 3/4% too high,
- interest not tax-deductible.

If you are going to do this, do it with a mortgage, taken at a much lower interest rate, preferably below 3%, and preferably in a situation where the full interest amount will be federally tax-deductible, at a marginal rate of 20-some or 30-some percent.

How can anybody be an expert on bubbles? Do they predict them beforehand? If they did with 100% certainty, let me know and I'll go to 150% equities. =)

But you are kind of missing the point in my original statement. Yes, what you've pointed out is lousy thinking. Most folks here see right through it for what it is. But the underlying message implicit in the foolhardy scheme is that the stock market is "no-lose". But, As more folks begin to believe that, *thats* when we get "bubbly".

Look, even you are subtly implying that leverage is an option. The only way it *can* be an option is if (the generic) you believe that the stock market can't fall. Because, if it did and were then somehow unable to pay for the mortgage... well, we all know how that went.

I'm seeing more and more threads here talking about the benefits of leverage in general. These discussions don't happen in the midst of a 2008. They only happen when we see lots of gains and everybody is feeling good. That's when money starts flowing in, and you get "bubbly".

That's not to say I'll ever be able to act on it. But I can observe and wait for the ride.

[joebh]

Jonathan Clements suggests taking out a 7 year new car loan at 3 to 4% and using the proceeds to buy stocks or stock funds. He also suggests not placing the funds into bonds/treasuries/a savings account.

Interesting.
Does he similarly suggest taking out every other loan you can get, and buying stocks?

[mindboggling]

Why are you even watching CNBC?

[nukewerker]

If a 7 year loan makes sense to use proceeds from financing a depreciating asset, why not go for the HELOC at 10 years or even better refinance and pull the equity out at a 30 year term.

these things never work out because it would only make sense when there was blood in the streets. Say 08. But it was a little hard to find capital then.

[garlandwhizzer]

The question here is leverage which works well in an exuberant bull market and can be disastrous in a severe bear market with debt service added to increased portfolio decline. Since no one can accurately predict these events in advance, adding leverage clearly involves increased risk especially so when the market is generously valued like at present. One thing to keep in mind when you're considering leverage in investing is the old adage: pigs get fat, hogs go to market.

Those who profit in some way from increasing stock trading volume (which I suspect includes Mr. Clements) often recommend more of that for the rest of us. Coincidence? I think not.

Garland Whizzer

[lack_ey]

A quick look at (US, NYSE reported) margin debt:
http://www.advisorperspectives.com/dsho ... he-SPX.php

Spoiler: margin debt is at an all-time high.

[garlandwhizzer]

Correction: Jonathan Clemens does not sell financial products, he sells books on investing. He may not be directly profiting from his advice but I personally think that taking out a 7 year car loan and investing the proceeds in equities is not sound advice for investors at this point in time.

Garland Whizzer

[mptness]

The question here is leverage which works well in an exuberant bull market and can be disastrous in a severe bear market with debt service added to increased portfolio decline. Since no one can accurately predict these events in advance, adding leverage clearly involves increased risk especially so when the market is generously valued like at present. One thing to keep in mind when you're considering leverage in investing is the old adage: pigs get fat, hogs go to market.

This sounds like sensible advice.

Correction: Jonathan Clemens does not sell financial products, he sells books on investing. He may not be directly profiting from his advice but I personally think that taking out a 7 year car loan and investing the proceeds in equities is not sound advice for investors at this point in time.

+1
In the past I have found him to give much more sensible advice.

[staythecourse]

I have been advocating this for awhile. Nice to see someone else agrees.

I just did this with a new car. I took a 63 month for a whopping 0.9% interest rate. It is no brainer. I took the money I would have put into the car and put it into the stock market instead. Even if the market produces less at 0.9% at the end of the 63 months that is not the point. The point is the opportunity to buy shares of an appreciating asset, i.e. stocks instead of depreciating asset, i.e. cars in exchange for an extra 0.9%. What are the chances of the money I put into a diverse group of stocks NOT going up >0.9% in my likely 50 yr. lifetime? Remember I am not selling the stocks at the end of the 63 months. I will be holding onto the stocks until I WANT to sell which for me is likely 20+ yrs. away at the very least.

My breakpoint was at 63 months as it was the furthest I could go out and NOT have to jump up in interest rates.

I think the key on taking on such debt is knowing if I wanted to I could pay it off overnight if I needed.

Good luck.

[livesoft]

Many people do not think about this (and mortgage loans, and credit card loans) the same way as I do. It seems that many people think: At the end of the loan term, what if the stock market has dropped a lot? That's a risk they do not want to take.

Instead of thinking that way, I think as follows: What if during (not always at the end) of the loan term, the stock market has gone way up? At that point in time, I can cash in my stock market gains and pay off the loan. In other words, there is a built-in option to pay off the loan when the stock market has cooperated. That's worth something. It would be rare for the stock market not to cooperate at some point during a multi-year time frame.

[joebh]

I have been advocating this for awhile. Nice to see someone else agrees.

I took the money I would have put into the car and put it into the stock market instead.

What was the money you would have put into the car doing before this point in time?

[Johno]

I just did this with a new car. I took a 63 month for a whopping 0.9% interest rate. It is no brainer. I took the money I would have put into the car and put it into the stock market instead. Even if the market produces less at 0.9% at the end of the 63 months that is not the point. The point is the opportunity to buy shares of an appreciating asset, i.e. stocks instead of depreciating asset, i.e. cars in exchange for an extra 0.9%. What are the chances of the money I put into a diverse group of stocks NOT going up >0.9% in my likely 50 yr. lifetime? Remember I am not selling the stocks at the end of the 63 months. I will be holding onto the stocks until I WANT to sell which for me is likely 20+ yrs. away at the very least.

My breakpoint was at 63 months as it was the furthest I could go out and NOT have to jump up in interest rates.

I think the key on taking on such debt is knowing if I wanted to I could pay it off overnight if I needed.

0.9% is a low rate, though note that the relevant maturity is around half of 63 months, since the loan amortizes practically straight line with almost zero rate. But the 'best CD' curve is around 1.45% in 2.6 yrs, say around 1% at 30% fed/state tax rate v non-deducible car loan: there's a narrow (almost) pure arbitrage there. That is, assuming taking the loan has no negative impact on the price of buying or maintaining (lender required insurance you don't need for example) the car.

The part about depreciated asset isn't relevant though. You would have bought a car either way, so the car's depreciation falls out of the equation for you. It's the lender's problem to accept a 'depreciating asset' as collateral, though the amortization of the loan is there to cover that, which is why we have to consider the loan's average not final maturity in comparison to other rates.

The estimation of stock returns is also not necessarily directly relevant. You can open a futures account and click 'buy' for an e-mini SP contract, $3 commission, and you are effectively taking out a loan at ~0.5% to buy ~$110,000 in the S&P, initial margin around $5k but it's up to the investor how much total cash to have in reserve against losses, all the way up to 100% or more. That implied interest rate is variable at around LIBOR+25; the car loan rate is fixed but equivalent to around LIBOR-13 (ie it's ~13bp below the LIBOR swap curve at the 2.6 yr point). So again the car loan does represent value *compared to other borrowing rates*, assuming it doesn't incur other costs. But over 2000-2012 I modeled futures leverage, LIBOR+25 borrowing rebalanced quarterly, and the highest return in that period was with leverage *less* than 1, even though the S&P had a positive total return (5.37%). For LIBOR-13 in the same period, the highest return was at 1.05:1 leverage, but only 1bp higher than the total return of 1:1. In a longer historical period 1988-2012 peak performance for LIBOR+25 leverage of the S&P was at 1.9:1 leverage, 2.6% pa more return than unleveraged (10.42%); for LIBOR-13 financing, 2:1 leverage had the highest return at 3.0% more than 1:1 leverage.

A cheaper borrowing is better all else equal, not just in 'theory' but as you can see in the real examples. X bps lower borrowing rate will improve return ~X bps at 2:1 leverage. Problem is, even 2:1 leverage on the S&P will backfire not that rarely. OTOH with lower leverage the overall impact of borrowing rate isn't as much. Anyway it's apples and oranges to count improved returns with a lower borrowing rate at high leverage compared to the expected return at no leverage. Constant % leverage not only produces more risk, it doesn't even necessarily increase multi-period return, in contrast to the misconception the (quasi-single period) CAPM graph tends to perpetuate (with its line of ever increasing return by ever increasing leverage of the tangent point on the efficient frontier).

The two reasonable ways to quantify the benefit of a 0.9% 2.6 avg life car loan is a) after tax arbitrage v the CD curve, ~10bps ~$75 for a $30k car loan or b) advantage in borrowing cost v the futures implied, ~38bps so ~$285, as a way to leverage *if* the person already planned to leverage. Counting it as the difference between the loan rate and historic returns in stocks under a quasi-single period assumption isn't correct.