Financial Decision Making: There Isn’t Always a Right Answer
AJ Ayers,
Co-Founder
CFP®, EA, CEP
In the dark days of the pandemic, I found myself staring out a window in someone else’s house about to present a webinar called “How to Buy a Car” for our clients.
It was something we had whipped up because so many of our clients were trapped in tiny New York City apartments and needed a way to escape the city, at least to some field or hiking trail for the day.
It was a wild time for the auto market. Used car prices had been steadily increasing at about 5% a year prior to 2019, but the demand for affordable cars (the supply chain disruption made getting new cars very difficult) jumped more than 15% in one year.
As financial planners, we knew it was a capital-B, BAD time to buy a used car, but our clients needed them, so we advised them on how to get them. A reliable used Subaru might have been easy to find in 2019 for $10-15k, but in the summer of 2020, you’d be lucky if you could find one for $18k.
Throughout 2020, car prices continued to rise, and interest rates continued to fall. People were scared about the rising death toll and the complete and total disruption to everyday life. The stock market was roaring and companies with business models that thrived in the pandemic were having fabulous IPOs. Many of the clients got richer and rushed to put offers in on second homes with banks dolling out mortgages at hilariously low rates between 2 and 3%.
When it’s cheap to borrow money, prices typically go up. Many clients flooded my inbox with questions about buying homes and cars. From where I was sitting, it felt like a fever dream, mad rush of consumerism. Of course, for some clients, a second home close to the city had always been in the financial plan. But for others, all of a sudden with the discomfort of two working parents trying to lead Zoom meetings from a shared second bedroom with a two-year-old, a second home was a need.
Clients (against my recommendations) were putting offers on homes they hadn’t even seen. Inspections were skipped, contingencies were waived, and the general inertia of needing to focus on something while the world appeared to be ending pushed many very smart rational people to act like chickens running around with their heads cut off.
And that’s okay. Not every big decision is the right one. And often there is no right answer.
Clients will say “AJ wouldn’t let me buy the house.” This isn’t actually true, I just presented people with another side of the story: you may think working from home is permanent.
But what happens when (if) this pandemic ends and you’re back in the office?
Are you going to commute four hours from the western Catskills to Manhattan?
Are you going to rent a pied-a-terre in the city to work while your kids live upstate because they’ve made so many friends up there you can’t bear to bring them back to the city?
Yes, 2% is a great mortgage rate but is $1.3 million dollars a lot to pay for a house that needs another $300,000 of work?
And by the way, we know from other clients that the waiting list for a contractor is 6-12 months.
We learned a lot during that time and we gave some good advice. That’s what we do as financial planners. We can see the forest from the trees.
We bring perspective and some rationality to decisions that are often completely irrational. We know that the economy is cyclical and discomfort/market dips/losses are typically temporary. We also know that boom times are temporary so we try to advise our clients to make the best decision to take advantage of a market rally or a windfall with the long term vision in mind.
But back to the car thing: 2020 was an absolutely terrible time to buy a car because of the low inventory and high prices. But a lot of us did it anyway because we needed to. But was it? Interest rates were so low that you could finance a car for a 2 to 5 year loan at close to ZERO percent. One client actually did pay 0% on a car loan. I didn’t believe them at first, LOL.
Fast forward to 2024 and it’s a much better time to buy a car, I guess? Supply chains are back to normal. Used car prices have stabilized. But what’s very different are the interest rates.
For a car loan, we’re looking at around 5% for a two year loan and almost 8% for a five year loan. These numbers are anecdotal because I am actually in the process of buying a car. And I have no idea what to do.
Should I buy something new so it has the best safety features and the most reliability?
Or should I buy something slightly used because cars lose value the moment you drive them off the lot.
Should I buy something fancy because I like nice things and it will make me happy, or should I buy something practical and cheaper?
And finally, should I pay cash or finance it?
Like most things in my life, my car shopping began with a powerpoint presentation to my husband about why we need a car. It was half a joke, half also to let him know I was serious. I tend to get excited about a lot of things. :)
A parking spot to rent had opened up in our building and I knew a car would mean we could take more day trips, explore beyond our neighborhood, and honestly expand my network of golf courses I could play. I started with a rough budget of $18,000 to see what the used car market had to offer. After a few hours of research (who knew there were so many car podcasts) - I landed on the perfect car for us: the Mazda CX-5, a used model from 2021 or 2022. A small SUV that could fit all of our shit (my golf clubs) and could still be parked on the streets of NYC. It was of course going to be beyond our budget, but only by a few thousand dollars I quickly rationalized to my husband as he rolled his eyes.
So I took the subway to the dealership and test drove the exact car I wanted. It was perfect. A little luxury at a great price and great safety scores. I didn’t buy the car on the spot and went home to think about it. As I played with the financing calculator on their website (a little slider adjusted the down payment, and a button changed the interest rate on the loan from 5 to 7% depending on the length).
I started laughing. I’m a frikken financial advisor who has helped literally hundreds of people make decisions like this, and I didn’t have a clue what the right answer was. It was all just feeling.
Sure, I could easily take the $23,000 out of savings and not deplete my emergency fund but why the hell would I do that when my cash is making 4.5% just sitting there? But if I finance, I’m paying almost 7% on money I already have? Do I want to add a monthly expense of a car loan on top of the new monthly expense of a parking spot?
In the end, I had to decide something. So I made the decision that was most squarely in the middle. I financed at the lowest rate for the shortest time period. It gave me options. I spent a little cash now, took on a larger monthly payment but only for two years. I knew I could pay it off at any time so that gave me a little boost of artificial confidence that I was making the right decision.
The answer I came up with needed to be the right answer so I could sleep at night, but there still isn’t a CORRECT answer to this problem.
A Not Perfect but Fairly Useful Framework for Evaluating Large Purchases (Or Leases)
Can you afford it?
Said another way, will you have to make cuts or changes to your lifestyle or spending to afford this thing? If you’ll have to make changes, chances are you CAN’T afford it. I’ve heard many people make the argument “we’ll travel less if we really love our home so we can afford to spend more on rent.” I call bullshit on that. You’ll travel the same amount, you will just be extremely stressed out that you can’t pay your rent and may watch your credit card balances tick up.
Have you tested the hypothesis that you need/like/want this thing?
I don’t just mean test drive the car. I mean, rent a car for a week to see what parking is like, do you actually use it?
This goes for houses too! I can’t believe it’s not the norm to sleep over in a multi-million dollar house before you buy it. But I do mean to spend time in the area. If you’re testing out a new town, go spend a week there in an AirBnB (in BOTH seasons! The hot and the cold one!).
Should you finance it?
It rarely makes sense to pay for a home purchase with cash. Of course everyone is different so talk to your financial planner first. BUT I will say that people who are obsessed with putting more cash down are often making an emotional decision. They want to feel better, they want to feel like their mortgage is more affordable by putting down a larger down payment. The numbers typically tell us that putting down MORE cash than is necessary (typically 20% is necessary) will leave you with less money in the long run (you should have invested that extra cash in the stock market). But again, it’s different every time.
For a smaller purchase, like a car, where paying all cash is more achievable, the decision is often simply one of personal preference. Don’t overthink it. If you have excess cash, sure buy the whole thing. If you're even one iota worried about not having enough liquid cash to get you through an emergency, then finance it. And don’t worry about a higher interest rate, you can almost always pay it off earlier without penalty.
Can You Get Out of it if you Change your Mind?
If the answer is no, you better be 110% sure this thing is the deepest desire of your heart. I’ve used this language a lot with clients and home purchases. If owning a home in Brooklyn is the deepest desire of your heart and you found the perfect home, then go for it. If not, you better have a very long and hard think about it because it is VERY difficult to sell a home (and often financially damaging) quickly after you purchase it, at least for the first five-ish years.
For something like a car purchase, sure you could always sell the car. But if you finance it, you could always pay it off sooner. So financing gives you more flexibility. And I am always in favor of flexibility.