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supersunbird
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Yes, he should be VERY happy about that, because the cash is earning an even higher return somewhere else in an appreciating asset...
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Buying a vehicle Cash vs Financing
- Thread starter spanx
- Start date
Yes, he should be VERY happy about that, because the cash is earning an even higher return somewhere else in an appreciating asset...
This decision is far from a no-brainer.
1st make sure that you compare apples to apples:
The 12.5% nominal interest rate offered by the bank for financing the vehicle equates to an effective rate of 13.2%. This is the rate you need to use to compare to expected (annual compounded) investment returns.
Inflation is currently 4.4%, so 13.2% represents a real after inflation return of 8.8%.
This is the return you will earn on your money guaranteed after tax if you use your cash to buy the car, because this is the interest payments saved in that scenario.
8.8% real, after tax, guaranteed is a big number. The best guaranteed after inflation rate out there currently is the 1.75% offered on SA retail bonds. The bank will be very happy to earn that return off you.
I assume when you say you are earning 20% returns on your investment for the last few years, that you refer to the compounded annual growth rate (cagr- this is the return shown in the fund’s fact sheet). If not, you are not comparing apples to apples.
I had a look at the last 5 and 10 years SA equity fund returns and found that over 5 years only 5 out of 118 equity funds (6.8%) achieved a cagr of more than 20%, over 10 years 4 of 75 (5.3%) achieved this return. Index funds tracking the Alsi achieved about 17.5% over 5 years and 17% over 10 years.
I also looked at the last 40 years returns over 5 year rolling periods for the Alsi and the MSCI World index. On average the JSE returned 6.7% and the MSCI World 5.9% after inflation over the 36 rolling 5 year periods. It was also very risky with the worst 5 year period losing 30% and 54% of real starting capital for the JSE and MSCI investments respectively. Compare this to the guaranteed 8.8%pa ( ie. 53% real return after 5 years) you can secure by paying cash for the car.
Only 9 of the 36 (25%) rolling 5 year periods achieved a real return greater than the 8.8%pa real return you will get by paying cash.
In short I don’t think it is realistic to expect 20% returns going forward on your investment. At best you should expect to earn about 11% (5% inflation and 6% real return) over the next 5 years, with a significant probability of a negative real return.
1st make sure that you compare apples to apples:
The 12.5% nominal interest rate offered by the bank for financing the vehicle equates to an effective rate of 13.2%. This is the rate you need to use to compare to expected (annual compounded) investment returns.
Inflation is currently 4.4%, so 13.2% represents a real after inflation return of 8.8%.
This is the return you will earn on your money guaranteed after tax if you use your cash to buy the car, because this is the interest payments saved in that scenario.
8.8% real, after tax, guaranteed is a big number. The best guaranteed after inflation rate out there currently is the 1.75% offered on SA retail bonds. The bank will be very happy to earn that return off you.
I assume when you say you are earning 20% returns on your investment for the last few years, that you refer to the compounded annual growth rate (cagr- this is the return shown in the fund’s fact sheet). If not, you are not comparing apples to apples.
I had a look at the last 5 and 10 years SA equity fund returns and found that over 5 years only 5 out of 118 equity funds (6.8%) achieved a cagr of more than 20%, over 10 years 4 of 75 (5.3%) achieved this return. Index funds tracking the Alsi achieved about 17.5% over 5 years and 17% over 10 years.
I also looked at the last 40 years returns over 5 year rolling periods for the Alsi and the MSCI World index. On average the JSE returned 6.7% and the MSCI World 5.9% after inflation over the 36 rolling 5 year periods. It was also very risky with the worst 5 year period losing 30% and 54% of real starting capital for the JSE and MSCI investments respectively. Compare this to the guaranteed 8.8%pa ( ie. 53% real return after 5 years) you can secure by paying cash for the car.
Only 9 of the 36 (25%) rolling 5 year periods achieved a real return greater than the 8.8%pa real return you will get by paying cash.
In short I don’t think it is realistic to expect 20% returns going forward on your investment. At best you should expect to earn about 11% (5% inflation and 6% real return) over the next 5 years, with a significant probability of a negative real return.
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I think your problem is that you are looking for validation to finance a vehicle you can’t afford.
Your future self will never forgive you for allowing the bank to earn 8.8% real off you over the next 5 years.
If you force yourself to call up your investment and pay cash for this car, you will quickly realise what a stupid idea it is to buy this car.
I have always forced myself to save up and pay cash for depreciating assets- this policy has served me well. It forces you to live within your means.
If you force yourself to pay cash, I bet you will reconsider the R300000 car and settle for a R200000 one. This will guarantee that you will be richer 5 years from now, whereas the numbers I posted above suggest you will be significantly poorer if you allow your greed to overrule your reason.
Your future self will never forgive you for allowing the bank to earn 8.8% real off you over the next 5 years.
If you force yourself to call up your investment and pay cash for this car, you will quickly realise what a stupid idea it is to buy this car.
I have always forced myself to save up and pay cash for depreciating assets- this policy has served me well. It forces you to live within your means.
If you force yourself to pay cash, I bet you will reconsider the R300000 car and settle for a R200000 one. This will guarantee that you will be richer 5 years from now, whereas the numbers I posted above suggest you will be significantly poorer if you allow your greed to overrule your reason.
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Nope, I can't decide. My head says one thing and my heart another. I'm not in a rush though and still need to think this through. Perhaps looking at a cheaper car would be a good option.
It's quite a tricky one. I just can't get over the fact that I would give up a good investment to buy something cash which would be losing value.
The issue of buying a depreciating asset is something you will have to wrestle with regardless of whether you choose to finance this purchase with your investment savings or by borrowing money.
That's true, it will be depreciating nonetheless. Which is perhaps why I should reconsider. This whole exercise actually forced me re-think all of this and left me wondering whether I REALLY need a new car. Which I don't by the way
I would be much better off in 5 years time if I decide not to buy at all even though I would be driving a 14 year old vehicle by then 
Maverick Jester
The Special One
- Joined
- Oct 18, 2011
- Messages
- 13,424
That's true, it will be depreciating nonetheless. Which is perhaps why I should reconsider. This whole exercise actually forced me re-think all of this and left me wondering whether I REALLY need a new car. Which I don't by the way
As long as your current vehicle is suitably maintained, the age for the most part is not a factor.