Monday, 20 June 2011

Should I get a car loan?

by Rob d'Apice
Post-GFC, 'debt' has become a much naughtier word: at best, a necessary burden; at worst, the harbinger of financial ruin.

Debt does have a positive role to play in personal finance, particularly in building investment assets (and, of course, most often for property). But how about using debt to finance depreciating assets?

According to this recent Commonwealth Bank advert, it's the best idea in the world!

Something about this ad just screams 'evil'. Perhaps it's the baritone, sensual, Shakespeare-inspired narration; perhaps it's the 'Meet Joe Black' suited Commonwealth Bank personification that happily hands the car keys to the helpless, naive youth; perhaps it's the allusion in the final line ("Happiness...") that a personal loan can bring young people all the joy and fulfilment that comes with the immediate gratification of acquiring things you can't afford, without any future consequence.

Yep, it's probably that last thing.

What's really so bad about buying a depreciating asset with debt? It's fairly simple: you're burning money on both interest (the money you owe the bank for your loan) and depreciation (the amount of value you lose in your car each year), and that means losing a lot of wealth.

Meet Kim and Tim

Kim and Tim are twins. They both have savings of $5,000, both have $400 per month of spare income to go toward savings or assets, and both desperately want to get some wheels.

Kim is an aspiring high-roller and wants a brand-spanking new VW Golf for $22,000. She puts in her $5,000 cash and gets a $17,000 personal loan from the good people at the Commonwealth Bank. Her $400 per month is going to the bank to pay off the loan

Tim, on the other hand, wants to save up for some property; he opts to buy a used car online for $5,000 - a 2001 VW Golf. He puts his $400 per month into an online savings account.

Meet Kim and Tim, 5 years later

In just 5 year's, Tim's wealth is now more than double that of Kim's. It's clear that Tim will be better off, but it's quite stark how big the difference really is.

Each person's net wealth can be considered as the sum of their car's value and their cash savings, less any outstanding debts they have.

Overall, Tim ends up with around $33k, made up of $30k in cash and $3k value left in his car. Kim's car will only be worth a bit over $12k, and she'll have just $3.5k in savings - less than half the total wealth of Tim.

So who took Kim's money?

There are two things that really hurt Kim.

1. Kim lost nearly $10k in her car's depreciation, Tim loses only $2k. We've taken our depreciation assumptions from a Choice guide to car depreciation: you'll lose about 14% of the car's value in the first three years, then about 8% per annum for the remainder. In reality, the cliché is true: as soon as you drive your car out of the dealership, you instantly lose a good chunk of money.

2. Kim will pay $5k in loan interest and fees; Tim will make about $4k in savings interest. It's well known that the path to wealth is to accumulate income-generating, capital-gaining assets, rather than load up with debts for depreciating assets. The difference in Kim and Tim's interest exposure is clear evidence of this.

A blow-by-blow account

Don't believe us? For the more numerically curious of you, we've mapped out Kim and Tim's financial position for the first five years to show you what drives the changes in their wealth.

What about running costs?

Yes: in this analysis, we've ignored the running costs of the cars. A new car under warranty often has free service for the first few years of the car's life, and registration doesn't require an inspection. On the other hand, comprehensive insurance can be more expensive (because the car is worth more). A newer car may also be more fuel efficient. While all these things are true, even if Tim's running costs were $1k more than Kim's every year, he would still be well ahead of Kim's financial position at the end of year 5.

What's your experience with car loans or personal loans? Do you have one? Has it worked for you? Let us know in the comments!

Friday, 17 June 2011

Revisiting First Home Savers Account: now an even better idea

by Rob d'Apice
Back in April, we wrote a post about the government's First Home Savers Account.

We talked about how it's good for two reasons:
  • For every $100 you put into the account, the government puts in $17
  • The tax payable on the interest earned in the account is capped at 15%

The downside to the scheme is the '4 Year Rule' - you need to make contributions of at least $1,000 in four different financial years before you could use the money to buy a house; and if you bought a house before then or changed your mind, the money would become locked up in your superannuation.

What's changed?

A friend of Prosple pointed out this recent change to the scheme which has relaxed the '4 Year Rule'.  If you buy a house before you have completed all 4 years, you can now withdraw the money after the remaining years have elapsed to use toward mortgage repayments - meaning that it's not locked away in super until your retirement.

So is it a good idea now?  If you are sure that you will one day want to buy a home in Australia, then it's hard to see how this is a bad idea (in fact, we're going to open one up right now).

Want another reason?

The 2010-11 Financial Year is coming to an end.  If you open an account now and make at least a $1,000 contribution before the end of June, you will have already satisfied one year of the 4 year requirement, meaning there's only a 3 year wait until you can get your funds.

Are you going to open an First Home Savers Account?  Let us know in the comments!

Thursday, 9 June 2011

Prosple on 2UE

by Rob d'Apice
Prosple was on 2UE last week discussing the value of Flybuys and reward credit cards.

Have a listen below (EDIT: or listen to it on the 2UE website)

Thursday, 2 June 2011

Are Flybuys actually worth it?

by Rob d'Apice
How many times have you been asked whether you have a Flybuys card? "Too many times, dear friend!" is what I'm imagining you saying, if you were somehow reading this as-yet-unpublished blog post. So today, we put pen to paper to help you demystify the truth behind the value of the FlyBuys Scheme.

The Math

To calculate the value of FlyBuys, there are three things we need to know:
Actual value to you
= [A. Your spend] x [B. Reward point earn rate] x [C. Value of a point].
A. Your spend
Flybuys points can be accrued at major Coles brands: Coles, Kmart, Target, BiLo and Liquorland. The amount of spend obviously varies for each person, but (at the risk of exposing the author's alcoholism or penchant for expensive deli goods) the author of this post has calculated his total spend at Coles and Liquorland for the previous 12 months as $978, so let's use $1,000 as a plausible annual spend.

B. Reward point earn rate
It's 2 points for every $5 - or 0.4 points per dollar.

C. Value of a point
Again, this depends on what you redeem with your points. Ironically, Flybuys' travel rewards are pretty average - domestic travel is available with Qantas or Virgin Blue, but international travel is very limited.  All Qantas travel still incurs taxes, etc.  We've calculated that redeeming points for a return trip to Brisbane equates to a point value of about $10 per 1000 points* (or $0.01 per point). FYI: Redemption for vouchers and other rewards is also possible, but equates to a point value of about $6-8 per 1000 points - a few dollars less than flight redemption.

*For you data-geeks out there: return flights to Brisbane is 22,500 Flybuys points PLUS taxes with Qantas.  The same flight through the Qantas website is $225.05 PLUS taxes.  Therefore 22,500 points = $225.05, which can be reduced to roughly 1 point = $0.01.

So, returning to our formula above:
Actual value to you
= [A. Your spend] x [B. Reward point earn rate] x [C. Value of a point]
= $1000 x 0.4 x 0.01
= $4.00

The Horrible Truth

Yes, you read that correctly.

In our example, Flybuys will return about $4 worth of rewards per annum.

The Lesson

Don't be generous with your trust. When an offer is confusing enough that you give up doing the math in your head, consider it a red flag.

Our goal is Prosple is to help cut through the crap.  That's why we have this blog, and that's why we are working furiously building a tool that can help you make decisions like these 24/7. For credit cards, for example, we put all available cards on a level playing field and produces a simple $ amount that each card will ultimately mean to you given your situation. You don't need to think through reward points, annual fees, interest rates, signup bonuses, etc. We're really excited about it because there's nothing like this in Australia (but more on that later!).

Got a Question?

This post came about in response to a reader's question.  Have you got a question that you're quietly sitting on?  Hit us with it!  We'd love to know what information you all need to dominate your financial life in this complex (and often manipulative) commercial world.

Until next time!