Common Sense Check: Investing While Having a Loan

[Benac]

Scenario Facts:
1. You have $20k in cash
2. You need a car
3. You like to hunt
4. Your investments average 12% YoY

Should you:
A) Pay cash for a $20k car; or
B) Take a 3.5% loan out for that $20k car, and invest the $20k (because you'll make 8.5% difference)

This has been one that I've been playing with. I do not like loans, but really like knowing I have money in the back (investments). Any insight would be greatly appreciated. Thanks!

 

[buckbull]

How many years would the car loan be for?

Averaging 12% may happen over the course of a car loan but that is doubtful. Personally, I think the bubble is going to burst. Student loan defaults will cause the next big economic crash.

If it were me, I'd put 10k down on the car, finance the rest. Put the remaining 10k into investments.

 

[Tradewind]

3.5% is cheap money and if you have investments with that return you should keep riding them.
take out the loan and buy a cheap (er) car

 

[bobbydean]

Take the cheap loan. It is a no brainer.

Stock market is very volatile.

I am in because I have always been in it.

Would stay on the sidelines for a new 20 grand investment. My opinion
+

 

[Corax]

The last 10 years have been a pretty continuous bull market. Cracks are starting to show, however, and last time around we had a 50% or so drop in the market. Long term returns are more like 2-3% over inflation.

On the other hand, it may be worth paying the 3.5% for financial flexibility.

Good luck.

 

[npaden]

It's a risk reward thing. No one can tell you what your personal aversion to risk is.

I had this same option come up a couple years ago. I took a 1.9% car loan out and made close to a 50% return the first year I left the money invested. More than enough to pay for the interest for the life of the car loan.

This year hasn't been so good. I've been up and down and am essentially flat with the same money.

The markets are a roller coaster right now. If you can live with that without getting an ulcer you might be able to make some money. But you might lose some money as well.

Risk vs. Reward.

 

[LaSportsman]

12% YOY isn't a guarantee. You didn't say stock so it may be something else but there is risk and volatility with all investments or everyone would be making 12%.

Last years YOY return will never be this years, good or bad.

You haven't said if it was in a tax deferred account or not.

Is the $20,000 yout entire cash position? You need a rainy day fund.

What is your cash flow for the CFA payment?

What is your tolerance for a bumpy ride?

These are just starter questions.

 

[VikingsGuy]

Well somebody has to say it "blow the 20k on a once in a lifetime hunting trip and take the loan to get the truck"

 

[JBS]

Assuming this is cash outside of retirement savings and emergency fund you should pay cash for a $7,000 to $10,000 vehicle invest $7,500 and use $2,500 to go on one or more great hunts.

 

[Frenchy]

Pay cash for the car. I'll be paying off my truck tomorrow. I bought it in November with a loan, but only with the knowledge that I'd have it paid off in under 6 months.

I'm done with debt payments. Never again.

 

[Frenchy]

If you had $200,000 equity in your house would you leverage that 200k at 3.5% to invest in the market?

 

[nhn2a]

I've struggled with this before but I always opt to pay cash and invest with extra money as available. My theory is if the stock market crashes, I still own everything i have paid cash for. Yes you COULD make more money but thats part of the gamble and just one that I dont feel comfortable making.

 

[npaden]

If you had $200,000 equity in your house would you leverage that 200k at 3.5% to invest in the market?

I personally think it's a smart money move to do so.

I could pay off my house with the money in my after tax brokerage account today if I wanted to. I just checked my performance on my brokerage account. 21.40% 10 year annualized return. 13.76% since inception that includes the 2008 correction.

You have to be willing to see some swings though. The first 3 months of this year my account was up $5,300.82 in January, down $7,620.29 in February and then back up $4,475.23 in March.

I invest in individual stocks that I feel like I have pretty good knowledge of what makes those companies work and what type of market fluctuations that they are subject to. Buy on bad news and sell on good news.

You could lose real money doing this though. I have had some down years no doubt. But if someone wants to lend me some money at 4% I feel pretty confident that I could earn more than that by investing the money.

I think the low low interest rates of the last decade or so are about to start creeping up.

My 2 cents. Don't take them as worth any more than that.

 

[VikingsGuy]

Setting aside my earlier snarky remark, one big question is, "how long until you need to access an investment of 20k"? If you have sufficient liquid cash on hand for foreseeable needs/emergencies and are saving for retirement in 20 years, a common low cost index fund will most certainly be a safe investment that would do better than 3%. But if you lack liquidity and might need to pull the money from the market (possibly at a low point) then I would just pay cash for the vehicle and keep life simple.

 

[Frenchy]

I guess my risk meter pegs out way before yours does. I'd take the paid for house every time. So likewise I'll take the paid for truck every time as well.

I'd suggest paying cash for the truck, and then invest/save what would have been your payment every month instead. Same thing with the mortgage.

Bad things happen, I'd like to be free from monthly payments when they do.

 

[Tubb2402]

So I'll throw my .02 in on this one.
1. Assuming the car is 20k, you finance for 5 years, and have 3.5% rate - you'll pay ~2k in interest. The question is at the end of the 5 years can you net more than the 2k in interest cost. Well assuming you can make 12% as in years past then yes. Even if you don't make 12%, all you need to make is greater than 3.5%, which to me should be easy.

2. In a financial crisis you will still have your 20k that is in stocks but still can get access to within a weeks time.

3. A car depreciates and the moment you buy it, it's harder to get the exact same money out of it. So in event of need you can't sell it for how much you paid for it. By doing a loan you will still have your 20k and and can also delay payments on car/sell it for what you owe. Now this may not good for credit but in a true time of need you may not be worried about that.

To me I'm having trouble seeing the upside to paying cash for the car. Other than you are having cash flow issues. It would be one thing if you did not have a steady income and didn't always know where funds were coming from. Assuming that's not the case finance the car and invest the cash would be the way I go.

Hope that helps

 

[Goatshoes]

If you feel its appropriate to seek financial advice from a hunting forum then you should stay away from investing altogether.

 

[Frenchy]

So, I was thinking about this a little more and since I'm a math nerd i ran some numbers. Given the 3.5% loan rate (probably a little low) and 12% return on investment, i compared your two outcomes assuming a 5 year loan

Invest the $20,000 at 12% and it will grow to $36,333.86 if left untouched. But the car loan will cost you $1,840 in interest. So the net result is about $34,500.
Pay cash for the car and invest the car payment of $364/mo for the same 5 years with the same 12% return and you would have an investment amount worth $29,700.

So all this mental wrangling results in about $4,800 difference over the 5 year period. Not exactly earth shattering.

 

[Steiny]

I don't like borrowing for depreciating assets like a car / truck.
Buy something you can pay cash for or save until you can.

12% Return is pretty good, but don't count on it to stay that way, you'll have some loser periods and periods of low return too.

 

[Elkmagnet]

I love this quote
"investing isn't just about making the biggest pile of money over your life time. It's about making the most you can while still being able to sleep at night"
So everyone is different.
I personally like the idea of paying cash for the car and making a comparable extra monthly "payment" to your portfolio. But that will take a good bit more self discipline.