Please help settle an argument

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DFWinvestor
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Please help settle an argument

Post by DFWinvestor » Wed Jul 23, 2014 1:02 pm

I was having an internet argument with someone and we both came to the conclusion we would post it on here and see what kind of responses we would get. If this is not appropriate to post I apologize in advance.

Argument A: It ALWAYS makes sense to take out a vehicle loan, as long as it is no greater than 3-5%, rather than pay cash for the vehicle up front. If you invest the cash in the S&P 500 you will always come out ahead.

Argument B: It depends on the circumstances. If the buyer is not maximizing retirement contributions, and paying cash for the vehicle would allow for pre-tax investments in the future, it might be better to pay cash for the vehicle. There are many variables to consider and in some instances it may not work out well to have invested in the market and borrowed for the car.

Thank you in advance for any and all feedback.

Van
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Re: Please help settle an argument

Post by Van » Wed Jul 23, 2014 1:05 pm

Without a crystal ball, there is no definitive answer that will settle your argument.

ourbrooks
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Re: Please help settle an argument

Post by ourbrooks » Wed Jul 23, 2014 1:11 pm

Historically, over rolling five year periods, the S&P 500 has had a loss 40% of the time. No one can predict in advance in which five year periods the S&P 500 will rise. Is this year a good year to take out a five year loan? What do you think the odds are that five years from now the S&P 500 will be higher than it is today?

Rando
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Re: Please help settle an argument

Post by Rando » Wed Jul 23, 2014 1:12 pm

Argument A is flawed in it's claims it will ALWAYS work. It won't always work.

B is more correct, although I'm not sure what it means by it depends on the circumstances. All you know is the circumstances when you begin the loan, and what happens after that is unpredictable.

billern
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Re: Please help settle an argument

Post by billern » Wed Jul 23, 2014 1:17 pm

DFWinvestor wrote:Argument A: It ALWAYS makes sense to take out a vehicle loan, as long as it is no greater than 3-5%, rather than pay cash for the vehicle up front. If you invest the cash in the S&P 500 you will always come out ahead.
Big picture, there is no guarantee that you will make money on an investment in the S&P 500 over any length of time. There are periods of time when you will lose money. Even with a 0% auto loan, you will not come out ahead using the funds to invest in the market if the investment loses money.

PS: Financing a vehicle requires that you have full insurance coverage, in some cases GAP insurance, and a low deductible. That costs more than what you might otherwise get for insurance.

Twins Fan
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Re: Please help settle an argument

Post by Twins Fan » Wed Jul 23, 2014 1:19 pm

Yep, wouldn't know until after the fact.

But, I would lean towards B. More along the lines of a guaranteed return though. Let's say someone has the cash to buy the car and could put it in a 5 year 1.5% CD and take a 5 year loan out on the car at 0.9%, or buy the car with cash. Sure, throw it in the CD and make out a little better. Although that wouldn't be enough of a "win" for me I'd pay cash, but just an example.

To leverage a depreciating asset like a car against the stock market though,... no thanks.

Just my take on it.

Also, Person B there could throw out the expected/predicted low returns of a real 4 - 5% going forward and see what Person A thinks about the loan then. I wouldn't make that bet.

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dodecahedron
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Re: Please help settle an argument

Post by dodecahedron » Wed Jul 23, 2014 1:26 pm

Twins Fan wrote:Yep, wouldn't know until after the fact.

But, I would lean towards B. More along the lines of a guaranteed return though. Let's say someone has the cash to buy the car and could put it in a 5 year 1.5% CD and take a 5 year loan out on the car at 0.9%, or buy the car with cash. Sure, throw it in the CD and make out a little better.
Taxes on the CD interest make this an even more marginal situation, especially if the financing requires purchase of a more expensive auto insurance policy than you would otherwise choose.

surfstar
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Re: Please help settle an argument

Post by surfstar » Wed Jul 23, 2014 1:30 pm

C - buy a cheap car that requires no loan (less than $5k)
D - bicycle
E - public transportation

.
.
.


Z - any of the above can work in any particular situation

:D

letsgobobby
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Re: Please help settle an argument

Post by letsgobobby » Wed Jul 23, 2014 1:33 pm

Always is almost always wrong.

Everything depends.

I'd borrow at 0%, but not 5%.

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Chan_va
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Re: Please help settle an argument

Post by Chan_va » Wed Jul 23, 2014 1:38 pm

Any argument that contains the word ALWAYS is ALWAYS wrong. How's that for a logical paradox

ABQ4804
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Re: Please help settle an argument

Post by ABQ4804 » Wed Jul 23, 2014 1:42 pm

Suggest Alternative C, and what we did: We got a better price on the car agreeing to finance thru their car dealership, I don't recall the rate, maybe 4%? Then you can tun around and refinance at a lower rate at you Credit Union, or pay it off immediately (which is what we did). The car dealerships really like buyers to use their financing. Hope this helps.

Calm Man
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Re: Please help settle an argument

Post by Calm Man » Wed Jul 23, 2014 1:48 pm

When one takes a car loan, one doesn't have title to the car. It hated that when I had a loan when I had my first car many years ago. Never again. We are in a world of low returns and low interest rates. Anything can go down in value just like up. If you have the cash, I say pay it. Quibbling about a percent or two on the purchase price of a car means there are a lot bigger fish to fry.

Jack FFR1846
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Re: Please help settle an argument

Post by Jack FFR1846 » Wed Jul 23, 2014 1:58 pm

I recently asked if I should finance my new car purchase at 1.24% and take $50k and open a fidelity acct to get a $200 bonus or pay cash. Answers were mostly to finance. In the end, I bought with cash. This goes to show that even when lots of internet posts say to do something, in the end, you need to do what is comfortable with. That is exactly what I did.
Bogle: Smart Beta is stupid

DFWinvestor
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Re: Please help settle an argument

Post by DFWinvestor » Wed Jul 23, 2014 2:17 pm

Thank you every one for the replies. My side of the argument was B. There are a lot of variables of course and if the timing of the market is right, you could come out way ahead investing the money and taking the loan. Then there are the hypotheticals such as the dot com bubble, and if you had invested in the market and taken the loan for the vehicle at that time (before the crash) you would be worse off. As opposed to investing month to month the money you would have been spending on a car payment as the market went down, and then back up.

Unfortunately we only know retrospectively which decision is best. There are some arguments to be made from both sides. My personal feeling is with the market currently at all time high it probably wouldn't be the best time to choose to invest the money and take out a loan. I also think it depends on the individual's circumstances, ie if someone has a bunch of cash lying around but isn't investing in a pre-tax retirement account I would argue is a little different than the person who is already maxing out and has a decent net worth.

Boglegrappler
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Re: Please help settle an argument

Post by Boglegrappler » Wed Jul 23, 2014 2:24 pm

Historically, over rolling five year periods, the S&P 500 has had a loss 40% of the time.
I am going to look this up, but I will be astounded if this is even close to being accurate.

Well, its a little closer than I would have thought. Using monthly data, since 1955, there are about 715 separate 5 year periods (rolling forward month-by-month), and about 19% of those periods show negative returns over those trailing five year periods. (not counting any dividends).

Dandy
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Re: Please help settle an argument

Post by Dandy » Wed Jul 23, 2014 5:26 pm

I vote B

as for A. 'Always" is usually a deal breaker in most arguments. Even without the Always word it is a losing argument. It is an argument that leverage is a great idea. The S&P usually does well over a 5 year period but nothing is guaranteed.

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Peter Foley
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Re: Please help settle an argument

Post by Peter Foley » Wed Jul 23, 2014 8:04 pm

I would vote "B" as well. There is a risk element in the return projected in A. If the loan rate were less than a CD or I-bond rate, then I would go the loan route.

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Toons
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Re: Please help settle an argument

Post by Toons » Wed Jul 23, 2014 8:16 pm

Definitively all I know for Certain is if I take out a loan between 3-5% I will be paying interest to someone else,other than myself,there by fattening their pocketbook. :happy

If I invest the cash in the S&P 500 I do NOT know for certain If I will come out ahead. :happy

Part B,I read and reread several times,I'm a little confused :shock:

Pay cash ,enjoy ownership immediately :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

sdaehelgob
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Re: Please help settle an argument

Post by sdaehelgob » Wed Jul 23, 2014 9:41 pm

Count the cost of extra insurance. Loans may make you take out comprehensive coverage, which you might not want to carry as a boglehead that drives conservatively. It could rival your interest cost, if you are young and male it could be prohibitive. When I was young some years I paid $2000 in insurance on a beater even though I had a clean record. A high cost neighborhood in a high cost state combined with a high risk demographic.

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BolderBoy
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Re: Please help settle an argument

Post by BolderBoy » Wed Jul 23, 2014 10:22 pm

DFWinvestor wrote: Argument A: It ALWAYS makes sense to take out a vehicle loan, as long as it is no greater than 3-5%, rather than pay cash for the vehicle up front. If you invest the cash in the S&P 500 you will always come out ahead.
This is nonsense. Most always/never declarations are.

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grabiner
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Re: Please help settle an argument

Post by grabiner » Thu Jul 24, 2014 12:01 am

sdaehelgob wrote:Count the cost of extra insurance. Loans may make you take out comprehensive coverage, which you might not want to carry as a boglehead that drives conservatively. It could rival your interest cost, if you are young and male it could be prohibitive. When I was young some years I paid $2000 in insurance on a beater even though I had a clean record. A high cost neighborhood in a high cost state combined with a high risk demographic.
And even if you do want insurance, you may not want the terms the lender requires. If your lender requires a $500 deductible on collision and comprehensive and you prefer $1000 or $2500, the extra insurance is an additional cost. (You will get some of it back in expected value if you have an accident, but not the full value; processing claims is expensive, and the difference in cost between $500 and $1000 deductibles includes the extra cost to the insurer of processing the small claims.)
Wiki David Grabiner

basspond
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Re: Please help settle an argument

Post by basspond » Thu Jul 24, 2014 4:48 am

A car is an expense item. It depreciates, so by financing you are increasing the cost of the item. If A is the answer than there shouldn't be a problem taking out a home equity loan in the same range and use the proceeds for living expenses. I would always vote B.

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midareff
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Re: Please help settle an argument

Post by midareff » Thu Jul 24, 2014 8:11 am

DFWinvestor wrote:I was having an internet argument with someone and we both came to the conclusion we would post it on here and see what kind of responses we would get. If this is not appropriate to post I apologize in advance.

Argument A: It ALWAYS makes sense to take out a vehicle loan, as long as it is no greater than 3-5%, rather than pay cash for the vehicle up front. If you invest the cash in the S&P 500 you will always come out ahead.

This statement is FALSE. 3-5% is a lot of interest and there is no guarantee the S&P500 will be higher than when the loan was taken out.

Argument B: It depends on the circumstances. If the buyer is not maximizing retirement contributions, and paying cash for the vehicle would allow for pre-tax investments in the future, it might be better to pay cash for the vehicle. There are many variables to consider and in some instances it may not work out well to have invested in the market and borrowed for the car.

I think you meant "and paying cash for the vehicle would not allow for pre-tax investments in the future" ? Regardless, 3-5% is a lot of interest without a tax advantage. If I could pay cash for the car AND maximize pre-tax investments that's the way to go. If I needed a car loan to continue to maximize pre-tax investments I would have to look at the interest rate carefully. 3-5% is too high in todays environment.

Thank you in advance for any and all feedback.

$iddhartha
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Re: Please help settle an argument

Post by $iddhartha » Thu Jul 24, 2014 8:17 am

I'm worried that for my working career an optimistic return for the S&P may end up being the equivalent of 3-5% annualized. So I'd take 5% to the bank every day and twice on Sunday (the day banks are traditionally closed :P ), but I've been told that I'm a worrier. :|

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