Approximately seven in ten Americans report that money is a significant source of stress (71 percent), according to the American Psychological Association. That is why I’m launching my Financial Health Series with Shawn Perkins, a personal financial advisor.
Chronic stress has been shown to cause chronic disease and wreaks havoc with your psychological and physical health. One of The Simple Life focuses is on nutrition and exercise, but is primarily about pursuing a truly healthy and happy life. Financial stress affects all of us at some point, so this is a great series to get your finances in order, which will ultimately lessen your stress, and make you a healthier person inside and out.
Gary Collins: Hey, this is Gary Collins, best selling author and www.thesimplelifenow.com. I’m here again with Shawn Perkins, with Principal Shield Financial. I’ll get that right one time. Today, we’re going to talk about five ways you lose money. Let’s use a little different term. It was capital purchases. Let’s just call it big purchases. How’s that sound? Does that sound a little better?
Shawn Perkins: Yeah.
Gary: Just explain to people what you mean by how they lose money by making big purchase items. A perfect example is paying cash for a car.
Shawn: You said big purchases would be a house, a car, anything of that type of…It could be a yacht. For you, it’d probably be a yacht.
Gary: Of course. Everyone knows I hang out with that kind of community. [laughs]
Shawn: Using a car as an example, let me start first with a phrase I use that puts this in perspective. When people pay cash, what they don’t understand is that everything you buy is 100 percent financed. Everything you buy is 100 percent financed. That’s confusing to some people. Let’s talk about a couple of reasons why people pay cash.
What do you think is the number one reason why people pay cash?
Gary: For me, it’s because I don’t like to finance things. I don’t want the payment.
Shawn: You don’t want the payment. What’s another reason why people don’t, they don’t want to finance stuff? They don’t want to pay the interest to the lender, the bank, the credit union, whoever. They don’t want to pay the interest. But I just said in the beginning is everything you buy is 100 percent financed.
Here’s an example of that. If you buy a car for $30,000, and you go to the car place to buy it, and you finance it with their financing, you’re getting a loan from the institution, and you’re paying it back.
If you have $30,000 in your savings account, and you pull money out of your account and pay for the car cash, you financed it because wherever you had that money was earning some rate of return, and now you’re not earning that rate of return. You are saving interest that you would otherwise pay to the lender, but you’re losing interest that you would earn on your money, had you left it in the account.
A couple of things are happening with that. First and foremost, let me give you an example of how those numbers would look. Let’s say you could borrow $30,000 from the car company at five percent interest. You’re going to have a payment of about $566 a month for the entire five years that you borrow that money. That means that you’ll pay back $33,968.
$30,000 of which was the money you borrowed. $3,968 is the interest that you would have paid over that five years. If you had $30,000 in the bank, and you were earning five percent, over that same five‑year period, that $30,000 would grow to $38,501. The interest portion is the $8,501. That’s what you would have earned.
In order to avoid paying $3,968 to the car company, you gave up the ability to earn $8,500 in interest, having left the money in the bank. That’s a loss of $4,533. That’s a loss of $4,533 if you were able to borrow at five percent and earn five percent, but we both know that car loans today are largely available at zero percent interest, 1.9 percent, 2.9 percent.
If you could get it at zero, then you obviously earn the entire five percent. If you get it at 1.9, 2.9, then you earn the difference between those two interest rates, all the while keeping your money in a liquid, safe environment, where you have access to it, should you need it. This brings me to another point that I want to make.
If you take that $30,000 out of your account, pay cash for the car, you now don’t have the $30,000. Let’s just say that that left you financially strapped while you were doing that, and then you suddenly needed access to the money. How do you get money, going forward? Most people have to borrow that money.
In your effort to not pay interest by borrowing it from the car company, you now might have to borrow it from another source, a credit union, a bank, a credit card. Now, you’re going to have to qualify to borrow that money, in many cases. If it’s an auto loan or if it’s a mortgage, you’re going to have to qualify. You have to get past what I call the four C’s of borrowing.
You’re going to have to have two approvals. You have to be qualified, and then the asset you’re borrowing against has to be qualified. If you’re using your house, that house has to qualify for the financing, as well. You’re going to be subject to whatever the interest rates are at that given time. If rates are higher then than they are today, that could be detrimental to you.
Then, the last thing is you’re going to be subject to whatever the closing costs are to get that money from whatever financing source. You lose liquidity, and now you have to qualify to get the money back. Those can definitely get in the way and cost you money. I want to talk about a concept of simple interest versus compound interest.
In the car loan I gave you, the simple interest was the $3,968. The reason that interest is less than the $8,501 on the other example in the bank is because simple interest is interest being charged against the declining balance. Every payment that you make on the car, the balance is going down, so the interest is calculated against a lower balance.
In a compound interest scenario, that $30,000, the interest you earn each year is being added to that account, allowing it to compound. We call that reinvestment of interest. You’re allowing it to compound, which is why it grows to so much of a bigger number. When you interrupt compounding, you’re resetting that compound interest curve. You’re losing interest.
That’s another way you lose money by how you pay for your major capital purchases. Something else to consider, with certain types of financing, more specifically, mortgages, they come with tax benefits. When you borrow that money, when you pay the interest, the IRS allows you to write off the interest on your taxes.
That means that in a situation where maybe you pay $20,000 in interest to the lender for the year, if the IRS lets you write that $20,000 off on your taxes, and that means you get a refund of $5,000 dollars, how much did you really pay in interest?
Gary: You paid $15,000.
Shawn: $15,000. If you look at it in those terms, you really only paid $15,000 instead of $20,000. If you don’t borrow money, you give up that deduction.
Gary: And you still have access to the money. I think that’s the key part, is especially on a house. I’ve done this for years. I pay cash for my cars. I’ve been doing that for at least the last 10 years. I’m torn on it, to be honest with you. There’s times when I’ve needed the money, and it’s in my car. But I hate car payments. It’s the psychological thing, more than anything.
It’s just I hate car payments. I don’t like them.
Shawn: That’s why we’ve talked about this in the first episode. I think we touched on it in the second episode, is a key, key thing to understand here. It’s when we talk about the things you and I are talking about in this series, we are not talking about rights versus wrongs. Who pays cash for a car or a house is not wrong, versus somebody who doesn’t is right.
It is simply about efficiency and inefficiency. If you pay cash for a house, are you wrong? No, you’ve got no payments, and you own the house, free and clear, and all those things that come with it. That’s not wrong.
It’s just that you may have been able to have or keep more of your money, had you financed it, left that money in an account, earning in a compound environment, taken the tax deductions, and so on. You might have access to a little bit more wealth than you would otherwise have. It doesn’t make you wrong. We’re not here to tell people that what they’re doing is wrong.
We’re here to share with them that there may be other ways that are more financially beneficial. That’s all we care about, is making sure they keep more of the money they earn.
Gary: It’s about leverage. That’s the bottom line. You hear that, especially me, as an entrepreneur, and you as well. It’s leveraging your money. Which is the best way to go, during a certain set of circumstances? I actually did finance my most recent big purchase, which was a new travel trailer. The reason I financed it is because I needed that money for other things.
Usually, I would have paid cash for it, but I realized and went, “No, I need that money free, in order to build my house that I’m doing right now, because I have to pay cash for that.” That one, I don’t have a choice. That’s an interesting way to look at it, too. I’m building off the grid, and it’s part of my off‑the‑grid project that people can see on YouTube, I want them to understand this, too.
I get a lot of questions on this. They go, “How are you doing that? How are you financed?” I go, “There’s no financing.” If you’re off the grid, you’re not connected. Off the grid means you’re not connected to a public utility. You’re not hooked up to the power, telephone, cable, basically. You can get away with it with the sewage. There’s iffy, weird rules there.
Wells, it depends, county, state. It’s very complicated. You got to figure that one out on your own. You have to pay cash. You cannot get a construction loan for an off‑the‑grid house, and you cannot get a conventional loan for an off‑the‑grid house. I had to use that money that I’d usually pay for the trailer and then use that to build the house.
But I also made a choice, because of the car I had. I had to buy a new truck last year, too, because I needed a bigger truck. My other truck wasn’t powerful enough for what I was doing, towing and everything. I went and traded my other truck in and then paid the balance in cash. I looked back and I went, “Ugh. God. Should I have done that?”
Now I do need it. It would have helped to have that money again to put towards the house. Now, I have to do it in stages because I don’t have that free access. I’m not going to build the house in one fell swoop. It’s going to be pieces. I got to piece it together, as I have the money. That’s changed my financial outlook, too, far as how I’m looking at where I’m pushing my money, where it’s going.
It’s all balanced upon how I’m going to build this house and time‑wise. You’re right. It made me look at my big purchases totally differently, in order to leverage my money.
Shawn: We tend to look at decisions regarding our finances in a very narrow window of time. We compartmentalize our lives, if you will. We look at the most recent 24 months surrounding any decision that we make. We tend to think that the circumstances that exist today, that’s the way it’s going to be forever. Sometimes, I use examples, and they strike a cord with people.
We assume that because we’re married today, we’re always going to be married. We look at the fact that because we’re employed today, we may always be employed. My wife recently went through a year layoff. It took her a year after getting laid off from being in a job 15 years to find another job. That year that she was laid off was not a good year for us.
It wasn’t a good year for her because of the mental tricks that being unemployed and you can’t find another job plays on you. Having made decisions about paying cash for everything and then she was without a job, we might have shorted ourselves on liquidity and money and the access to liquid cash in an emergency situation.
That’s a big, big thing, is keeping access to your cash. You already made that point. One other thing I’ll point out there, and this is going to affect more long‑term financing than short, but inflation can play a major role in our borrowing decisions. What I mean by that is, when you get a mortgage for the first time…My 24‑year‑old son’s looking at buying a condo right now.
I’ll use him as an example. For that condo payment, he’s looking at about $2,100 a month. For him, at 24 years old, only in his second job out of college, that $2,100 represents a significant amount of money to him, on a monthly basis. It’s a big part of his budget.
If he keeps that condo, though, for say 5 or even 10 years, that $2,100 is going to become a smaller and smaller and smaller portion of his budget, and the house payment will become more and more affordable for him. Even though he’s still paying interest on the loan, he still has the monthly payment, it doesn’t feel like it’s costing him as much money, because he’s now making more money.
His income goes up with inflation, but his mortgage payment stays the same. If you have longer term financing, now they’re coming out with 7 to 10‑year financing, depending on the vehicle that you buy, the longer that you have that vehicle financed, the less impact that monthly payment’s going to have on your budget.
Your most valuable dollars are the dollars that you have today, because they’re the least affected by inflation. You can put those to work for you in today’s current interest rate environment and even the future interest rate environment. The example would be if you think interest rates are going to rise.
Gary: They’re definitely going to go up. They have to.
Shawn: If you can lock in long‑term financing today at, say, four, four and a half percent, or even zero on a car loan, or four, four and a half percent on a long‑term mortgage, and you can invest that money a year, two years, three years from now at 5, 6, 7, 8, 10 percent, because interest rates have risen.
You’re only paying four percent for the money that you borrowed from the bank, but you’re earning 6, 8, 10 percent where it’s invested. You get those different benefits by considering what options are available to you and not just simply making decisions in a vacuum, which is, “I don’t want any payments, and I don’t want to pay interest.”
Let me ask you this. If you pay $30,000 cash for the car, do you have a payment?
Gary: Technically, you do, because I took that money out of anything that I could have financed into. The problem with most people today, though, is they’re not using that chunk of money and making interest on it in a smart way, either. They’re actually losing on both ends if they don’t finance. It’s that balance.
You got to figure out, “I have this money. I need to put it somewhere where it’s going to make money for me.” That’s another tough one. Through different financial vehicles and investment vehicles, sometimes those tie your money up. You can’t get the money out for a period of time. Money market accounts are pretty much nonexistent now.
Back in the day, you could get four or five percent. They’re around, but the interest rate is so low. It makes it tough.
Shawn: You keyed in on something in the beginning of that particular part, which was what you don’t have is a structured payment. You don’t have a lender that tells you, “Send me $566.14 a month on the car loan,” if you pay cash. What you do have now, though, is an unstructured payment, which is you need to put the money back into your account to get ready for the next car you want to pay cash for.
Gary: That’s very true.
Shawn: What’s the problem? It’s a benefit, but what’s the problem of an unstructured payment? If we don’t have somebody telling us how much we have to send and how often we have to send it, we largely won’t do it. It takes a lot of discipline to do that. For those that have that discipline, kudos to you. Maybe that plan works good for you.
But for those that don’t, and I include myself in that ‑‑ discipline is something that you have to work on every day ‑‑ you may find yourself not having as much money as you’d otherwise have, had you had somebody telling you, “You have to put this much away every month, no questions, no arguments.”
There’s several things to consider. I think that it’s not a right or wrong. It’s just simply what’s beneficial to you. What other types of financing are available? Does it make sense for you to pay cash, versus finance?
Gary: Absolutely. It’s a variable, depending on who you are, time, circumstances, where you are in your life, what you’re trying to accomplish financially. With that being said, for people who want to get your services and get your great experience in these matters, where can they get a hold of you?
Shawn: My website is www.principalshield.com, principal being spelled P‑R‑I‑N‑C‑I‑P‑A‑L. My email address is email@example.com. My cell phone number 619 area code, 994‑1110. My blog address is another way to see these kinds of things that we’re talking about in a written word, so you can benefit from them on a weekly basis, as I post blogs, is www.wiseandwealthyblog.com.
Gary: Thanks a lot, Shawn. People can get a hold of me at firstname.lastname@example.org. Hopefully, we get some good questions. We’ll have some future…This is part five of our final series, but there’ll be more financial episodes on various topics in the future. Thanks again.
Shawn: Thank you, Gary. I appreciate the help…
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