(October 3, 2003) For many advisors, financial plans take in the “big picture” — things like saving for retirement and maximizing estate potential. But financial planning principles also apply to seemingly smaller events in a client’s life, which nevertheless constitute “big ticket,” such as buying a house or a car, says advisor and author Éric Brassard.
“Clients do give money away by inadvertently negotiating bad deals,” Brassard said this week at the Advisor Forum in Montreal, reminding advisors that homes represent a sizable part of most household budgets.
The cost of financing a home forces clients to skip other elements of a holistic or integrated financial plan, he said. However, thanks to a paucity of competent consumer information, clients are ill-equipped to properly assess those costs.
Brassard, the author of two consumer-oriented books A Home at My Price and Finance Behind the Wheel, thinks advisors should be applying financial planning concepts to these major purchases. “When we talk about integrated financial planning, it’s not pie charts with bright colours. It means calling us before making a major decision,” adding that “I don’t want to find out after the fact that a client has made a terrible blunder.”
With many consumer purchases, salespeople are acting as financial advisors, even though they are simply trying to close a sale by, for example, pointing buyers to a convenient loan program. “It’s incredible to hear what a salesperson says,” Brassard says. To financial advisors, he points out, “It’s up to you to fill that void.” As examples of common misconceptions, he cites the popular belief that smaller lease payments mean ultimately a lower cost for a purchase. Depending on interest rates, it may mean the exact opposite.
On a deeper level, a car lease from a legal perspective looks like a rental agreement. But it’s actually quite different. “Long-term leasing is an example of an area where there’s a lot of nonsense” a competent advisor can dispel, Brassard says. In a car lease, there is a guaranteed residual value of the car that can be compared to the market value over so many months of depreciation. This residual value, Brassard says, is actually a depreciation insurance policy, and while it might have a tiny value for a subcompact, it’s not trivial for a luxury car.
Beyond that, leasing means taking on debt. “It should be called a rental loan,” he explains. “The true nature of leasing is: I own a car. I have a debt. I can exercise the purchase option at any time.”
Leasing deals can be assessed in the same way as mortgage payment streams: what part is a capital payment and what is an interest payment. A leasing arrangement is simply a way to finance the purchase of car; and when the leasing agreement is up, the client can refinance the purchase or pay down the debt. “The question is not whether to get another car; it’s whether to refinance your debt,” and part of the answer, Brassard says, lies in making clients aware of the cost of money.
Money has a time value: “a dollar now is worth more than $1 in 48 months.” Whether it makes sense to lease or buy depends on understanding the client’s situation, and one question Brassard asks is: “do you need a car?”
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The cost of money includes interest rates; but it also includes opportunity costs. Paying cash for the car may mean less money available to pay down credit cards, contribute to an RRSP or an RESP. “Cash is not always the least costly option.”
Then there’s the computation of the monthly costs, not just the lease, but operating costs, accumulated equity in the car, as against the time value of money, and what a monthly budget can sustain.
There’s also the specific elements of the contract, including promotions, car exchange, discounts, the term of the lease, and so on. They all affect the actual cost of the car. “You should never buy a car at the end of the lease,” he says. Better to lease another car and accept the $1,000 interest payment, then to step into a $5,000 depreciation.
Similarly, a downpayment on a lease can be costly, because the client then loses some element of the residual guarantee, should the car be stolen or become a write-off. Still another scenario concerns exchanging cars. In that instance, the client keeps liquidity, albeit at higher monthly payments.
In the end, buying or leasing a car is not as simple a decision as it seems. More than that, Brassard says, auto journalism is poorly informed. It’s one area where an advisor can turn their skills, and evaluate the true costs among alternatives. It’s also an area an advisor would be wise not to neglect since, “your client will lose money through making bad decisions.”
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Filed by Scot Blythe, Advisor.ca, sblythe@advisor.ca
(10/03/03)