What is the real cost of debt?
In an age where it is easier to show off and let the world see your toys than ever before in human history, it becomes quite compelling to always have the latest and greatest in everything. Often, people are taking on debt in order to fund a lifestyle that is beyond their means. But what is the real cost??
One of the best and ultimate simplest pieces of advice that I can give an individual is to invest first and spend what is left over. Too many people tend to spend first and then invest the rest, if they invest at all.
The asset where I see the most people making a mistake that hurts their financial position are cars. Rather than just saying buying expensive cars is a poor decision lets actually have a look at the numbers and see what the real cost of a more expensive car can be.
Michael has $20,000 saved and has decided that he would like to buy a new car. He is debating between buying a car for $20,000 or using his $20,000 as a deposit and borrowing $20,000 to purchase a more expensive car. To keep it simple, lets assume that both cars use the same amount of fuel and ongoing servicing/repairs are the same. He believes that after 5 years he will be able to sell the car for 50% of what he pays for it.
Having had a look at the available loan rates Michael has a found a car loan with a 5 year repayment period, fixed interest rate of 8.49% and a monthly repayment $410. Over the 5 years Michael will pay back a total of $24,600.
Michael is a high growth investor and believes that if he buys an Australian Share ETF he will be able to return an average of 8% p.a. over the 5 years. He has done some research and has found that the ASX 200 has returned an average of around 8% p.a. over the long term.
If he was to use that same $410 per month that his monthly car payments would be to invest in the market at the end of the 5 years he would have an investment portfolio valued at $31,172.
In the scenario where Michael decides to take a loan to buy the more expensive car, he will finish the time period with an asset value of $20,000. Should Michael decide to buy the cheaper car, he will have a car worth $10,000 and an investment portfolio of $31,172 for a total value of $41,172. Over a 5 year period this is a difference of over $20,000.
Additionally, at the end of the 5 years Michael will continue to hold assets of $31,172 that will continue to grow and provide him with a passive income build his wealth over the long term.
Before you take on additional debt, have a think and ask yourself what is this going to really cost.
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