I'm New and This Makes No Sense to Me

[Fredster4]

I am brand new to MMM concepts so bear with me.

OK this post is on the topic of debt. MMM says treat all debt as an emergency. I get that to a certain extent. I bought a new car before being introduced to the concepts of MMM and I have a huge loan on it. I have all the money sitting in investment accounts to pay off this debt if I wanted to but why should I? My auto loan is for 1.9% and the money I have invested is in index funds that have made 11% annually on average for the last 50 years. In the last 5 years, that has only been 8% annually but still, this has been a huge benefit to me to keep the money invested at this annual return rather than paying off a 1.9% debt. If we can keep the responses within the context of numbers and bottom lines, not emotional and "the principle of the thing" that would be greatly appreciated. In other words, the idea that I will sleep better at night with this debt paid off, gains no mileage with me. The idea that the Stock Market can go down is also a weak point because I'm working with long range numbers here. Thanks in advance.

Fredster4

[Chris22]

You are correct that MMM's viewpoint here is mathematically indefensible. 

[Northwestie]

I am brand new to MMM concepts so bear with me.

OK this post is on the topic of debt. MMM says treat all debt as an emergency. I get that to a certain extent. I bought a new car before being introduced to the concepts of MMM and I have a huge loan on it. I have all the money sitting in investment accounts to pay off this debt if I wanted to but why should I? My auto loan is for 1.9% and the money I have invested is in index funds that have made 11% annually on average for the last 50 years. In the last 5 years, that has only been 8% annually but still, this has been a huge benefit to me to keep the money invested at this annual return rather than paying off a 1.9% debt. If we can keep the responses within the context of numbers and bottom lines, not emotional and "the principle of the thing" that would be greatly appreciated. In other words, the idea that I will sleep better at night with this debt paid off, gains no mileage with me. The idea that the Stock Market can go down is also a weak point because I'm working with long range numbers here. Thanks in advance.

Fredster4

In context I think this is fine.  But you're likely to hear "why the heck did you buy a new car in the first place that you have to leverage" - options - good used car, less expensive new car.    But you acknowledge that you purchased before getting on board with MMM - so the crowd may only implement a minor beat-down.  :)

[Milizard]

With my understanding of MMM, the biggest objection would be to spending a lot of money on a new vehicle, instead of a cheap, fuel-efficient used car.  Then, you are supposed to get a really nice bike, and use that for transportation at least 95% of the time.  The debt issue is minor in comparison.

[Travis]

MMM isn't quite anti-debt like Dave Ramsey, but his "hair on fire" analysis usually pertains to folks who are up their eyeballs in debt (like credit cards and unnecessarily large and expensive cars) and have little to nothing invested in the first place.  This question comes up here on the forums on a fairly regular basis. The consensus seems to be if the interest rate on the debt is 4% or less and you have a healthy index fund portfolio going then it's safe to let it ride.

[Nick_Miller]

Well, we're in a similar boat (I mean car), down to the 1.9% rate.

We're taking the middle road of paying it down pretty aggressively, but not at the sake of trying to invest as much as possible.

Arguments for paying down the car ASAP I suppose would be:

1) yes it's just 1.9% but it's a guaranteed return. This is an election year so who knows how the market will react if Trump wins,

2) you have to keep collision, comprehensive, etc. coverages on your vehicle as long as the finance company has the title (you would probably keep the coverages for a few years anyway),

3) paying down the car, which most people here would likely view as an extravagant purchase, depending on your exact situation, guarantees that you increase your net worth, whereas you might blow the money on entertainment, etc., with any money you "save" from not making the biggest payments possible (you don't sound like that sort of person though)

I know these aren't the strongest arguments, but you wanted to stick just to math!

[Jack]

The consensus seems to be if the interest rate on the debt is 4% or less and you have a healthy index fund portfolio going then it's safe to let it ride.

You missed a condition:

"... and if the availability of financing doesn't cause you to buy a more expensive thing than you would choose otherwise..."

[ketchup]

2) you have to keep collision, comprehensive, etc. coverages on your vehicle as long as the finance company has the title (you would probably keep the coverages for a few years anyway),

This is truly the main reason I'm so averse personally to a new/newish car.  I can make the rest allllmost pencil out (we do a lot of driving), but needing full coverage on a financed-or-not new/ish car totally breaks the equation.  Even if I paid cash, I'm not in a position where I'd feel comfortable driving around an asset like that unless it was fully insured (if bad luck or a fuckup costs me a $1-3k car I could eat that much more easily than if bad luck or a fuckup cost me a $15k car).

[rente39]

My auto loan is for 1.9% and the money I have invested is in index funds that have made 11% annually on average for the last 50 years. In the last 5 years, that has only been 8% annually but still, this has been a huge benefit to me to keep the money invested at this annual return rather than paying off a 1.9% debt.

At the moment we have very low interest rates and you should factor this in when predicting market returns. Otherwise you could think the setup you have is great with low interest rates and bad with high ones. But it's not, it's the same thing because the market prices reflect interest rates as well.

The shiller PE (as an example for return prediction) for the S&P 500 stands at about 27 today, thus "predicting" a long-term market return of 3.7%. This is pre-tax and not considering transaction costs or annual fee. Taking 0.2% of fees and transaction costs and a 15% tax rate as an example, you'd come out around 3% net return.

So you are "earning" only 1.1% for taking the risks already mentioned.

[Mississippi Mudstache]

I bought a new car before being introduced to the concepts of MMM and I have a huge loan on it.

The problem is not that you have debt at a reasonable interest rate; the problem is that you have a new car with a huge loan on it. How much more money could you invest each month if you didn't have to service the debt on the clown car? Ditch the expensive new car and buy an efficient, used car in the $10K range. Or don't. Nobody's holding a gun to your head. But you need to be aware of the real cost of your choice, and it isn't 1.9% interest. It's the fact that you have a gigantic depreciating-asset anchor chained to your cojones.

[hoping2retire35]

2) you have to keep collision, comprehensive, etc. coverages on your vehicle as long as the finance company has the title (you would probably keep the coverages for a few years anyway),

This is truly the main reason I'm so averse personally to a new/newish car.  I can make the rest allllmost pencil out (we do a lot of driving), but needing full coverage on a financed-or-not new/ish car totally breaks the equation.  Even if I paid cash, I'm not in a position where I'd feel comfortable driving around an asset like that unless it was fully insured (if bad luck or a fuckup costs me a $1-3k car I could eat that much more easily than if bad luck or a fuckup cost me a $15k car).

this is what makes having a car loan slight too expensive. For the double coverage of comprehensive you roughly have to add 3 points of interest to the equation. You can work the math out your self but I bet once you add in the additional insurance realistically you should say you are buying a car at ~4.9%.

but then even if you paid it off you have to consider what if you wrecked it. Could you easily buy another? Insurance companies are in the business to make money, you don't have to help them. This basically equates to having a sub $5k car and probably a sub $3k car to make financial sense.

[moof]

I'll throw in a negative comment.  Buying your car for cash is worthwhile, even if you end up losing out on some investment returns.  Having to scrape up $30k by selling assets for a new car in itself should give you real pause and encourage you to buy less car.

Your personality may be better than most, but it is very easy to end up with a lot more car than you every needed, and even more than you ever wanted simply by the sales guy putting everything in terms of payments and being in the heat of the moment.  Your depreciating asset is still quite likely losing money faster than the preserved investments are making returns, which is the argument for buying a 7-10 year old car that is already off the steep part of the depreciation curve, yet still in good shape and pretty current on safety features.

[TheStachery]

I bought a new car before being introduced to the concepts of MMM and I have a huge loan on it.

The problem is not that you have debt at a reasonable interest rate; the problem is that you have a new car with a huge loan on it. How much more money could you invest each month if you didn't have to service the debt on the clown car? Ditch the expensive new car and buy an efficient, used car in the $10K range. Or don't. Nobody's holding a gun to your head. But you need to be aware of the real cost of your choice, and it isn't 1.9% interest. It's the fact that you have a gigantic depreciating-asset anchor chained to your cojones.

This is the correct answer.

[MilesTeg]

MMM operates from a core of good advice, but often takes his ideas to an absurd extreme.

If you actually have the money to buy the car and/or pay off the debt then you are in a decent financial position and there is no reason to eat the opportunity cost of not borrowing that money. The opportunity cost, of course, is the money you can (and are) earning on that sum in other investments.

The best rule for borrowing money is:

1.) Don't borrow money for things you can't afford (fancy cars, too big a house, etc.)
2.) If you can afford the purchase, always consider the opportunity cost of paying for the purchase with cash.

[MilesTeg]

I bought a new car before being introduced to the concepts of MMM and I have a huge loan on it.

The problem is not that you have debt at a reasonable interest rate; the problem is that you have a new car with a huge loan on it. How much more money could you invest each month if you didn't have to service the debt on the clown car? Ditch the expensive new car and buy an efficient, used car in the $10K range. Or don't. Nobody's holding a gun to your head. But you need to be aware of the real cost of your choice, and it isn't 1.9% interest. It's the fact that you have a gigantic depreciating-asset anchor chained to your cojones.

This is the correct answer.

Nah, the correct question is: "Can I reasonably afford this purchase without compromising my personal financial goals". And the correct answer is up to individuals, not the MMM group think.

[MMMarbleheader]

http://www.mrmoneymustache.com/2011/11/28/new-cars-and-auto-financing-stupid-or-sensible/

Good post on money tied up in Auto Inventory

[Chris22]

http://www.mrmoneymustache.com/2011/11/28/new-cars-and-auto-financing-stupid-or-sensible/

Good post on money tied up in Auto Inventory

IF you are all in on the "Thou Shalt Worship Thy Bicycle" facet of MMM. 

[Digital Dogma]

2) you have to keep collision, comprehensive, etc. coverages on your vehicle as long as the finance company has the title (you would probably keep the coverages for a few years anyway),

This is truly the main reason I'm so averse personally to a new/newish car.  I can make the rest allllmost pencil out (we do a lot of driving), but needing full coverage on a financed-or-not new/ish car totally breaks the equation.  Even if I paid cash, I'm not in a position where I'd feel comfortable driving around an asset like that unless it was fully insured (if bad luck or a fuckup costs me a $1-3k car I could eat that much more easily than if bad luck or a fuckup cost me a $15k car).

this is what makes having a car loan slight too expensive. For the double coverage of comprehensive you roughly have to add 3 points of interest to the equation. You can work the math out your self but I bet once you add in the additional insurance realistically you should say you are buying a car at ~4.9%.

As I understand it the 4% rule only applies over a statistically significant number of years, and a statistically significant sample size is way larger than the typical auto loan. Its not inconceivable that the market could return -2% for a couple years, taking longer than the lifetime of the loan to average back out to +4%, all the while the cost of servicing the debt and insuring the bank's vehicle is eating into your potential contributions to your index funds over that time. I've always thought it was somewhat fool hardy to accept debt with the assumption that you're going to outperform the lender in the market based on past performance. If those market returns were as rock solid as advertised there probably wouldn't be anyone offering loans at 1.9% for a guaranteed opportunity cost loss of 2% per year.

[Travis]

The consensus seems to be if the interest rate on the debt is 4% or less and you have a healthy index fund portfolio going then it's safe to let it ride.

You missed a condition:

"... and if the availability of financing doesn't cause you to buy a more expensive thing than you would choose otherwise..."

We could probably add a few caveats to my statement, but around here by the time we jump down this rabbit hole once a month we're simply tweaking an already financially-ideal position.

That being said, after re-reading the posts here it's possible/likely the OP is already paying for too much vehicle.

[soccerluvof4]

If you have invested in index funds with a return of 11% for 45 years and 8% the last 5 then why would you be financing anything?

[spots]

I think others hit on this, but in case not . . . .

Moustachianism does not suggest that you forgo investing in order to pay off this debt. Moustachianism would suggest that you (1) sell the car, (2) use the proceeds from the car sale to pay off the debt, and (3) buy a much cheaper car, enabling you to increase your level of monthly investment.

[mathlete]

Like all debt vs. investment problems, it is a question of higher mean returns vs. lower volatility.

The correct answer is in the risk-appetite of the beholder.

[englishteacheralex]

Everybody else already said it better than me. But cars are a depreciating asset. The correct Mustachian strategy is to pay cash for something used, cheap, and reliable. Service it well and you-tube DIY basic repairs. Don't get comprehensive insurance on it. Drive it into the ground. Put the money you save into appreciating assets. Paying interest on an already depreciating asset that costs you money makes poor financial sense.

People are irrational about cars. Over the past 15 years of making my own auto purchases, I have owned:

1. A 1996 Toyota Corolla with 90k miles. Purchased for $4,500. Drove it for 9 years to 140k miles. Sold for $1100. Had a few major repairs on it totaling $2300 over the time I owned it.
2. A 1999 Toyota Corolla with 45k miles (bought from someone's grandma for $2500). Drove it for 6 years to 70k miles. Sold for $1200 to a friend. Made almost zero repairs over the time I owned it.
3. A 2003 Toyota Matrix with 98k miles. Bought for $3300. Still driving it. No repairs yet.

If you do the math, I haven't had to spend very much for transportation over the years. One time I carefully did the math and realized that my cars/insurance/gas/maintenance were costing me almost the same as a $60/month bus pass would.

[undercover]

If you have invested in index funds with a return of 11% for 45 years and 8% the last 5 then why would you be financing anything?

My thoughts exactly. Shouldn't OP be retired by now? In which case - buy whatever you want.

The whole "hair on fire" thing is directed towards those that just keep going into high interest debt and keep buying consumer goods on credit with little to zero savings/investments. It's not really directed at you, OP.

But yes, if you must have a new vehicle than borrowing at 1.9% to invest at ~7% is not a bad idea.

[neil]

It is very difficult for individuals to secure loans without a corporate profit structure around it.  Usually, when an individual gets a "deal" on borrowing rate, there is a larger context behind it where the business still profits.  If you see through this and avoid the traps, then you can be better off in those scenarios.  Most people do not, and thus the companies profit greatly.  (All those credit card cash back programs exist because they are profitable.)

For the majority of the population, it is purely a psychological test and they fail early and often.  Thus, when giving advice to the general population, you'll win more people over by guiding them toward conservative finances.  There's no liability protection on your personal finances.  If you go bust, you have to live with that for the rest of your life.  Dave Ramsey pushes the "no debt" approach the hardest (generally only allowing for personal homes and cashflowing everything else).  He's very popular because it works universally despite being suboptimal.

Dave Ramsey's defense to zero percent debt and credit card offers is the fact that no one gets rich because of that.  It rings true because you still need a solid cash flow in the first place to retire either early or well.  Grinding out credit card bonuses is a nice benefit to disciplined purchasing activity but it doesn't change my retirement date in any meaningful fashion nor would I consider it an essential part of the budget.  Living a modest lifestyle that maximizes happiness and saving/investing at a crazy rate is powerful.  Debt can be temporarily useful but cannot provide any freedom by itself.

TL/DR?  You can do what you want, but the simple plan works for the most people.