By Kevin M

One of the biggest line items in a typical household budget is car expense, and one of the reasons it’s so large is because of car loans. After decades of easy credit, we’ve been conditioned to think of car loans as a normal part of the car buying process. I have a car, therefore I have a loan.

But is that the way we should be thinking? Are there deeper risks to having a car loan that we tend to gloss over? I think so. The loan you sign on for when you’re safely employed can quickly become unsustainable after just a few months of unemployment. And with job losses and extended periods of unemployment becoming the “new normal” we should be changing our assumptions about car loans.

What are some of the reasons you should avoid a loan and pay cash for your next car?

A loan puts your car at risk

Unlike credit cards—where the lender has no specific claim on your assets—it you fall behind on your car loan, your car can be repossessed. This reason alone should remove any casual notions we have about car loans. They’re higher risk than almost any other loan type! Even if your house is foreclosed on, there is an extended period of due process that can take a year or more in many states, giving you valuable time to maneuver. No such protections exist for a car loan; stop paying and the repossession process is pretty swift.

A car is a survival asset for most people

For most people, a car is critical to their ability to earn a living, if only for commuting. If the car is lost—which is much more likely during a period of extended unemployment—your ability to earn a living will be greatly impaired. You can lose your wide screen TV, your $3,000 deluxe treadmill or even your home and still be able to earn a living. Not so with a car; lose it and your job prospects collapse immediately.

The double car payment trap

One car loan is bad enough, but as a testament to the casual way people often see them, many households have two or more. All of the problems of one car loan are multiplied by the number of loans outstanding. In some households total car payments can exceed the monthly house payment.

High cash flow drain

A car is an expensive proposition to begin with; you already have insurance, gas, repairs and maintenance. A car payment magnifies all of this. In fact if you total up all the expenses you pay each year to own a car you’ll see why your money just seems to disappear into thin air. For most people, a car is the second most expensive budget item, after a home. By paying cash for a car, you cut this expense considerably.

Owing more on the car than the car is worth

This is also referred to as being “upside down”–for obvious reasons. Cars depreciate rapidly, so it’s possible to be upside down shortly after purchase, even after making a 20% down payment.

This situation creates at least two problems that I can think of. First, it limits your options if you want to sell the car or refinance the loan—you’re no longer talking about an 80% loan, but maybe a 110% or 120% loan. Or you could face a loss on sale.

Second is an insurance claim. In the event you’re involved in a crash and the insurance company totals your vehicle, they will only cover an amount up to the value of the car before the crash. That may mean a settlement that is not enough to payoff the loan, let alone provide for the down payment on a new car. Gap car insurance exists for this purpose, but few people purchase it unless the car is leased or the car is purchased with little or no money down.

Owing less on the car than it’s worth

On the surface I’ll admit that this one doesn’t seem to be a problem. But let’s imagine that you’ve been unemployed for about a year and you’ve fallen behind on your car payments. Your car is worth $15,000 but you still owe $5,000 on it, and the bank is repossessing it. You’ll lose a $15,000 car and the $10,000 equity you had in it will evaporate for the inability to pay a $5,000 loan.

Equity for your next car

The equity in the car you own today will probably make up most of the cash you pay on the next car you buy. By owning your car free and clear, not only do you maximize the amount of cash you have for the next purchase, but you also keep your options open to make the buy at any time. You won’t need to wait until the loan is paid, or worse, having to deal with the complications that come with selling an indebted car.

You don’t need a car loan if you work from home

Millions of people are now working from home, whether they’re self-employed or telecommuting. You don’t need to have a car loan if you work from home, in fact you don’t even need much of a car at all. A ten year old “beater” that works for short local hops is really all you need (you can rent a car for long trips if you don’t trust your beater to get you there). It makes no sense to borrow to pay for a car you’re hardly using.

 
What’s the alternative? Most obviously, don’t borrow to buy a car—paying cash is the way to go. Fortunately, there’s a car for every budget, especially if you can overcome the dreaded affliction newcaritus. And there are other ways to deal with car loans in the event you already have one.

1. Buy only as much car as you can afford to pay cash for; it that’s $2,000 for a 15 year old car, then that’s what you can afford.
2. Dedicate a savings account specifically to accumulate money for your next car.
3. If you have a car loan now, make paying it off a priority, even ahead of your credit cards.
4. If you have loans on two cars, make a priority of paying off the smallest as soon as possible—then go after the bigger one.
5. If you do use a loan to buy a car, make the largest down payment possible and the term as short as possible, then pay it off early.

Have you ever thought about the risks of financing a car? What do you think about paying cash, even if that means buying an older, less expensive one?

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By Alban

You want your investment portfolio to be strong and profitable to make gains which can set you up for the future and retirement of your dreams. However, it is also important to remember that these investments have still been made with your funds, and while your money is out there working hard for you, you are going on without it.

So what happens when you hit a financial bump in the road and your emergency savings fund just won’t cover it? Then you need to think out reeling in those investments, and often in a financial emergency, time is of the essence. Therefore, when it comes to your investments, you need to think about how they will be there for you in the future, as well as how easily they can come to your aid now, and that depends on the liquidity of your investments.

What is a liquid investment?

The liquidity of your investments is not only important in an emergency, but can affect how you access your funds in retirement, or when you want to pay for your child’s education. If your investments are not sufficiently liquid or they are too liquid, you can make losses, and even find you don’t have enough funds for your retirement because you have been investing in short term investments to maintain liquidity, but you still had a long term goal.

In a financial sense, liquidity is the accessibility of an investment, that is, how long it would take to arrive in your wallet if you decided you needed the funds today. For example, the funds in your retirement account are not liquid because to redeem the funds you need to complete paperwork, and wait for the money to be transferred to your bank account. However, money market funds are a highly liquid investment because you can often access the funds through a linked cheque book or bank account.

Liquidity can also be defined with regards to the volatility of an investment. For example, an investment can also be referred to as lacking liquidity if the removal of the investment will result in a loss, that is, while it may be fast and easy to convert the cash invested in a stock so it can arrive in your bank account within days, stocks should be invested for the long term, and removing the stocks quickly can result in a loss of value. While the volatility of the stock doesn’t directly affect the liquidity of an investment, it can affect whether it is a good financial decision to liquidate the investment.

Types of Liquid Investments

Each type of investment has a different level of liquidity and volatility when liquidated and it makes for a strong financial strategy to have a mix of high and low liquidity investments, to minimise the volatility of your portfolio. For a mix of liquidity levels, choose from the following types of investments:

• Money market accounts. Investing in the money market is very similar to investing cash in a savings account, but offers a much higher return, without compromising liquidity. There is also very little fluctuation in a money market investment which makes the account safe and reliable, especially if you need to access your funds in a financial emergency.
• Savings account. A savings account is a traditional form of investment and means your funds can be as liquid as if they were in your everyday transaction account. High interest savings accounts are often linked to a transaction account with the same provider, to make for easy regular deposits, and quick withdrawals.
• Annuities. An annuity is when money you have earned on an investment is distributed to you on a set schedule, usually quarterly, six monthly or annually. Annuities are most popular as retirement funds as they are able to maintain a fixed and stable income for you after you have stopped working. As a result, annuities have a significant lack of liquidity and because they are designed to provide an income stream it is very hard, if not impossible to remove the original invested amount. The volatility of annuities will depend on where they are invested as some contain both stock and money market investments.
• Stocks and bonds. Stocks, bonds and mutual funds should be seen to have very little liquidity because even though it is possible to access your invested funds quickly and easily, these types of investments are designed to remain untouched for a certain period of time, for the best returns. Stocks and bonds can be invested for anywhere upwards of one year, the period of time will be relative to how long it will take to recoup the original investment.

How to Achieve Investment Liquidity

We have all become aware of how unpredictable and damaging investment markets can be in recent years, and being able to access funds in an emergency is more important than ever. Therefore, it is important to achieve a balance of long term and short term investments, where your short term investments can be easily liquidated without significant loss, and your long term investments can be left to grow in value over time.

To achieve investment liquidity, you need to look for investment options which have maturity dates in the medium to long term, but can easily and without too much loss, be sold before that date in an emergency. This means you have liquidity if you need it, but you are still making strong returns on your investments in the meantime. These investments should feature:

• Issue in a negotiable format. When investments are issued in a negotiable format they can be sold to a dealer or a bank and delivered for payment. Non-negotiable investments are those which have been issued by local financial institutions and are physically held at the institution, or are held by you as the investor. Also be aware that some investments cannot be sold before their maturity date, and are not negotiable.
• Issued by recognised entities. To make sure your investments can be easily liquidated, make sure they are issued by entities which are recognised, or are traded extensively within the investment community. This will make it easier to complete a sale or trade, if your investments are from a well know institution.
• Low default risk. Make sure your investment has a good credit rating and therefore a low risk of default. Investments with good credit ratings are consistently traded in active markets. However, investments issued by institutions with a bad credit rating can be difficult to sell, and if you do sell them, the price will usually be much lower than the value you originally paid.

When you have investments with these features you can then look for those which offer the highest yields, including longer term investment options. Just remember that if interest rates go up, the market value of an interest bearing security will go down, and the longer the maturity date on that investment, the greater the change will be to the market price.

Therefore, make sure to balance short term maturities which mature in 30 days or less, with long term investments of two or more years. This balance can help you meet emergency cash needs, and if you require additional funds, the entire portfolio is liquid and can be sold.

Alban is a personal finance writer at Home Loan Finder, a home loan comparison website.

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Cash Is a Strategic Asset Class

The following is a guest post by Rob Bennett of A Rich Life. While it is not the intention of this site to present and offer investment advice to visitors, Rob offers a conservative approach that may be of value to anyone who is in a career change, debt reduction, or other type of financial transition, and represents a refreshing approach that offers a counter to the prevailing financial culture that recommends heavy and permanent positions in stocks—an investment class which is more risky than most people commonly understand.–Kevin Mercadante

Many people believe that stocks are always the best asset class for middle-class investors. It’s not so and I can show this with numbers.

The price that you pay for stocks obviously affects the long-term return you obtain from them. But have you ever gone to the trouble to check how much overpricing affects the return obtained? I have, and the results of my investigation were eye-opening for me.

I have a calculator at my web site called “The Stock-Return Predictor” that uses a regression analysis of the historical stock-return data to reveal the most likely 10-year annualized real return from the purchase of a broad index fund made at any of the various possible valuation levels. At the top of the insane bull market, stocks were priced at three times fair value. Can you guess how much that amount of overvaluation brought down the “usual” return on stocks (6.5 percent real, or about 10 percent after factoring in inflation)?

The answer is –

The most likely 10-year return on an index fund purchased in January 2000 was a negative 1 percent. Yikes! That’s not a one-time negative return. That’s a negative return (on average) every year for ten years running.

So much for “Stocks for the Long Run”! And “Buy-and-Hold”! And “Timing Never Works!” And all the other cute marketing slogans pushed on middle-class investors by The Stock-Selling Industry!

Those open to looking at safer asset classes were not doomed to a negative long-term return on their retirement money. Treasury Inflation-Protected Securities (TIPS), an asset class that comes with a government guarantee attached, were paying at the time 4 percent real.

Do that math. TIPS were likely to beat stocks by 5 full percentage points of return for 10 years running. The investor who moved from stocks to TIPS when stock prices went insane set himself up for achieving retirement many years sooner by doing so.

Why then weren’t we told? Why did we hear only the pro-stock marketing slogans?

Nobody makes much money promoting TIPS or other cash-like investment classes. The “experts” in the investing advice field HATE cash. No commissions. No acceptance into the “Experts” Club. No appeal to the Get Rich Quick impulse lurking within each and every one of us that tempts us into ignoring price when choosing our investment classes.

It gets better (or worse, depending on your perspective).

The investor who moved to cash when stock prices went insane has far more in his portfolio to invest in stocks now that they are again priced reasonably. I also have calculators at my site allowing you to determine how much of a difference valuation-informed investing makes. The short version of the story is — investing rationally rather than going along with the marketing slogans (which, like all marketing slogans, appeal primarily to the emotions) permits you retire at least five years sooner.

If only there were commissions paid to those who recommend investing in cash at appropriate times!

But wait. It gets even better (or worse) yet.

Rational cash investors are today ahead of emotional stock investors by a significant margin. But that margin is going to grow larger and larger over the years. Do you know how they always tell us that saving a dollar produces huge financial gains in the long term through the magic of compounding? It works that way with avoiding stock losses too. Every dollar you protected by moving to cash when stock prices went insane is going to be multiplied many times over in coming years through the magic of compounding returns.

Cash is a strategic asset class. That’s what it comes down to. Cash isn’t just for sissies anymore. Cash is for those who don’t like to see their portfolios wiped out by the dubious investment advice of glorified salesmen. Cash is for aspiring early retirees. Cash rocks!

Stocks rock too. When purchased at reasonable prices, stocks offer a long-term value proposition far better than cash. Stocks are great. Stocks are the middle-class investor’s best friend. I love stocks.

But I ain’t one of those “experts” working on behalf of The Stock-Selling Industry. I get a kick out of cash too.

Rob Bennett is author of the A Rich Life blog and co-creator of “The Stock-Return Predictor,” a calculator that reveals the long-term value proposition of stocks purchased at any of the various possible valuation levels.