A RECENT email from a reader highlighted the importance of understanding numbers when you are borrowing.
The issue was the best way to buy a car. Her friend had invested $10000 in a managed fund 10 years ago and the value was now $24,000.
Without talking about options with her, he redeemed the capital of $24,000, paid capital gains tax, and then bought a second hand car for cash.
She argued that he would have been better off to borrow the money to buy the car and leave the managed funds intact. She wrote to ask if I agreed.
I certainly did agree. For starters, I hate to see investments cashed in, especially to buy depreciating assets such as motor vehicles - money, once used, tends not to be replaced.
Anybody who is considering borrowing for depreciating items, such as a car or furniture, should understand that if the term is fairly short the interest rate doesn't matter very much. For example, if he had obtained a personal loan for $24,000 at 9% interest and paid it back over two years the total interest payable would be just $2315.
That's a tiny amount in the scheme of things.
There is also the opportunity cost of cashing in the managed funds. If they achieved 9% per annum the value after two years would be around $28,500. The potential capital gain is more than the interest that would have been payable.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: firstname.lastname@example.org.
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