<OT> Re: Financial question (interest accumulation)

[Brian M Kennedy <kennedy@xxxxxx>]

Sorry for this long response, but this email thread fails to mention some 
key issues -- and I'd hate for someone to lose big money...

Stephen Lafredo wrote:
> 
> :I disagree with you that paying interest on a car is not a good and sound
> :financial decision. If you have the cash to spend on purchasing a car,
> :shouldn't you keep that cash and finance the car as long as the car loan
> :has an interest rate lower than your return on investment.
> 
> Your 100% right on this!
>
> I did this for a retired family member. They wanted a new MB. The car was
> slightly under $35,000, tax, tags, etc. I took $30,000 and put it in a
> simple Index 500 fund, which has been averaging ~20%, probably will not
> continue. The loan was for 7.5% and I selected the longer 5 year loan.
> 
> It has been two years now. The Index 500 fund is worth somewhere around
> $36,000 and two years worth of car payments have been made!
> 
> When I originally started this, I was ONLY hoping to make enough interest
> so that the last payment for the car would be the last dollars in the fund
> and hopefully only owe a few buck more. Instead, if thing keep going the
> way they are there will probably be a surplus of cash in the fund.
> 
> So ANY time you can earn more on your money than you are PAYING to use
> it the deal is good.


Careful!!  Three words:  taxes, fees, and risk.


Taxes.  Assume the market continues its charge for the next 5 years and you invest
in a fund that matches the S&P 500.  You make about 15% -- but have to pay 28-31% of
that earnings back to the IRS (assuming you are not retired, as in Stephen's
example).  That leaves you only 10%.  Do you also have state income taxes?  If so,
subtract that out.  Some of you may already be at break-even with a 7.5% loan.

Fees.  If you try to do, as implied above, draw off the fund to pay the loan
payments, you may find the fees totally absorb your gains.  Fees can be levied per
transaction (the originaly buy and each of the monthly sales), levied on the
front-end (when you buy), or levied on the back-end (when you sell) based on how
long ago you bought.  Other funds can levy annual fees.  These fees will usually
consume all the remaining after-tax differences, plus some.  I think most people
would already be losing money.  Though some may still be on the plus side (such as
Stephen's retired family member).

Risk.  All the above is assuming we get another 5 years of unprecedented growth in
the stock market.  It may happen -- but it is, in fact, not too likely.  A large
market correction or a couple small ones could easily leave you much worse off.


QUESTION:  Where can you find a super-safe investment that would earn you 7.5%
tax-free?  (Such an investment would be _ideal_ for a retired person -- but is also
good for most people who don't have lots to invest.)

ANSWER:  Right now, such an investment would be tough to find.  Typically, 5%
tax-free or after-tax is very good for very low risk.  3.5% is much more common
after-tax return on low-risk investments.  But you get exactly that by using your
cash to pay off a 7.5% (non-mortgage) loan.  There is zero-risk.  And you
effectively get the full 7.5% (or whatever your loan rate) return tax-free.


Brian

Disclaimer:  Never take investment advice off a newsgroup -- consult a professional
(which I am not).  I know nothing about investing, taxes, loans, or cars.  The above
is not investment advice -- I am not recommending you do anything in particular.  At
most, I was pointing out some issues you might want to consider -- issues that may
or may not be issues at all -- and I surely did not raise all the issues you should
consider.  YMMV.  ;^)

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