You’ve all likely heard the common saying “Cash is King,” but is that the motto you should be living by? I’d venture to say that properly using leverage to allow for compounding interest and growth is king, and the key to creating real wealth.
Let’s think about a possible scenario of an investment opportunity that you needed $60,000 to pursue, but you recently purchased a car for $60,000 cash. You may have to miss that opportunity because the liquid capital needed is no longer there. Instead, you own an illiquid, depreciating asset.
I’ve heard it many times before, “I don’t like debt, can’t I just pay cash for the car?” In most cases, our answer back is no, it’s not an efficient use of your money. Let’s continue the example from above, assuming you instead purchased the car for $60,000 and financed the full amount over 5 years at 2.9%. After 5 years you will have paid $64,527.43 in principal and interest payments. After one year, your car will likely be worth 20% less than what you bought it for. After that steep first-year dip, that new car will depreciate by 15–25% every year until it hits the five-year mark. After five years, that new car will have lost around 60% of its value. By this point you will have paid $64,527 to own an asset now worth $24,000.
In comparison, let’s say you instead invested that $60,000 of cash you were going to use for the vehicle and earned an average of 4% annually. After 5 years, you have an asset worth $73,260. The potential to earn $13,000+ of growth on an asset that can retain its value vs. the risk of paying $4,500 in interest on an asset that loses its value far outweighs buying a vehicle with cash. That’s called opportunity cost and it’s something we analyze with every decision our clients make.
If you own a business, you can stretch this even further with a tax exemption; Section 179. This allows you to depreciate certain vehicles 100% in the first year, a deduction against earnings. The tax savings would far outweigh the interest payments and you’d have the money invested for growth – a double win. However, this can be tricky so please consult us or your CPA before assuming this is the right choice for you.
At Crown Wealth, we always want to look at your financial well-being from the big picture point of view, rather than with a narrow and simplistic approach. With the holidays around the corner, big purchases are looming, and we would love to discuss whether financing or cash is your best option.
Zac O'Brien, CFP - Managing Director - North