Should you pay for a vehicle in cash or take advantage of low-interest financing to invest your money and out-earn your loan?
The idea of making minimum payments on an auto loan so you can invest as much money as possible seems exciting. But what does money expert Clark Howard think?
A podcast listener recently asked him this question after getting offered a 1.5% auto loan on a Tesla Model Y.
“I plan to pay in full with money [I’ve] saved,” the listener wrote. “However, some are saying paying cash is dumb and that I should invest the money in the stock market. What would you do? Pay the car in full or borrow at that 1.5%? I’m torn.”
Clark’s answer was unequivocal and demonstrative: pay in cash and forget about it.
“Cash is king! Cash is it. You have earned the reward of not having to pay interest at all,” Clark says. “You can’t expect, ‘Well, I’m going to earn more on it. So I should borrow money at 1.5%.’ Uh-uh. Pay cash. Be done. Know you own that Model Y free and clear.”
Table of Contents
- Why Investing Instead of Paying Cash Is Risky
- Finance vs. Cash Decision: The Nerdy Math
- Investing vs. Paying in Cash: Additional Circumstances To Consider
Why Investing Instead of Paying Cash Is Risky
It’s possible to earn enough money investing to outperform your auto loan. But it’s not guaranteed. You could take a significant loss on your investment during the term of the loan.
Taking on debt in order to deploy cash is called leveraged investing.
While the listener’s question isn’t quite margin investing, taking on any debt in order to invest is risky.
Clark says his position on the topic hasn’t changed for decades. He’ll always try to dissuade you from taking a loan in order to put your capital at risk — at least when your time frame is just a few years.
He considers a true investment to be 10 years minimum.
“Long-term, of course being invested in the stock market pays huge benefits to you,” Clark says. “But we’re not talking long term here with the comparison you presented to me.”
Finance vs. Cash Decision: The Nerdy Math
Let’s take a closer look at the risks and rewards this decision presents.
The most common auto loan term is 72 months (six years). However, Clark says 42 months (3.5 years) is the maximum term you should accept.
The MSRP on a 2022 Tesla Model Y starts at $58,990. After taxes and configurations, let’s assume a $70,000 cost with a $10,000 down payment.
On a 36-month loan at 1.5% interest, you’d pay $1,397.61 in total interest. But how much money would your cash make in the S&P 500?
Stock Market Decline: How Big Is the Risk?
That sounds like a no-brainer. Assuming that rate of return, investing the $60,000 would earn you $81,394 by the end of the 36-month loan. You’d net about $20,000 in profit after accounting for the interest on your loan.
If you could guarantee those numbers, you’d take that every day of the week and twice on Sundays.
Feeling especially confident that your investment bet will turn up green and not red? That could have something to do with recent performance. In the last decade, from 2012 to 2021, the S&P 500 averaged a 14.8% return. Just one year finished in the red.
However, relative to earnings, stocks are overvalued at the moment. That doesn’t mean that the market will stop going up or that some sort of crash is imminent. But it typically means that returns looking forward won’t be as strong as they have been.
“The alternative of taking the money and investing it in the stock market at a time where stocks are so highly valued is riskier even than in normal times,” Clark says.
There are no guarantees with investing. During the financial crisis, the S&P 500 fell 46.1% during the 16-month period that ended March 2009.
Can you imagine watching half of your $60,000 getting wiped out while you pay interest on your loan? When you could have had the Tesla Model Y free and clear with no debt?
Clark says you shouldn’t open yourself up to that potential outcome.
Investing vs. Paying in Cash: Additional Circumstances To Consider
Clark doesn’t know every detail of a listener’s financial life. He answers questions with some unknowns. He also has to consider that, although he’s answering a question for one individual, many other people are listening to the advice he’s giving.
In a real-world situation, you can potentially account for several more factors.
Clark says it’s important to build an emergency fund for unforeseen expenses. You never want to be in a position where you have to use a high-interest credit card to pay for an unexpected car repair or medical bill. Clark is a fan of paying off debt and saving at the same time for this reason.
Back to financing the vehicle purchase versus paying in cash: consider your debts and savings.
If you have a pile of high-interest debt and would totally deplete your emergency savings by investing, you shouldn’t think about it at all. Instead, reconsider buying the expensive vehicle (or at least finance it at 1.5% instead of paying cash). Then work on paying off your high-interest debt while maintaining an emergency fund.
Let’s say that you have no debt, enough of an emergency fund to finance more than six months of expenses and some other relatively liquid assets (such as CDs or short-term bonds). The chance that the stock market could decline is the same. But the consequences if that happens aren’t nearly as crippling.
You can always take bigger risks to chase bigger returns. (At some point, there’s probably an element of greed.)
In this instance, taking a risk isn’t necessary. Clark’s podcast listener can pay for the Tesla in cash — then invest every extra dollar they make going forward.
Clark strongly encourages everyone with the money in hand to pay in cash. He says true investing means holding for at least 10 years. A timeline of a few years or less can be considered speculating.
There are worse things you can do with your money than making a bet on the U.S. stock market, though, especially if you have no other debt and it doesn’t affect your emergency fund.
In most years, the stock market is going to outperform a 1.5% return. But investing in this situation is gambling. If you want to go against Clark’s advice, be mentally and financially prepared to lose just in case.