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Savings and a new car

Chris Farrell Dec 9, 2011

Question: My current car is getting up there both in years and in miles, and I’d like to replace it before anything major goes horribly wrong. I’m planning to spend between $20,000 and $25,000 on my next car, and I’m trying to decide the best way to pay for it. With either option, I have about half that sum in cash set aside specifically for this purpose, so my question is about the remaining amount. 

If I sell some of the stock I’ve accumulated in my Employee Stock Purchase Plan (that I’ve held long enough to pay only capital gains tax on), I should be able to pay for the car in full in cash. Ultimately I want to sell some of this stock regardless; too large a proportion of my finances is currently tied to the success of my company. 

The other option is to finance the other half of the purchase. My credit score is pretty good and I’ve got no other loans, so I was thinking it might be worthwhile to take out a small car loan while interest rates are so low, just to build up my credit history (as I’ve never had a major loan before). Plus, this would allow me to be more flexible with my cash in case something else comes up over the next 2-3 years. 

Which route would you recommend? Thank you! Arcadiy, Atlanta, GA 

Answer: I like a number of things you’re doing. For one thing, you’re setting aside a large sum of money for your next car even before trouble starts with your current one. Not only is it prudent, but many people say they’re going to do it but don’t. You did. 

For another, you realize you need to diversify away from owning so much stock in the company where you work. The most telling example of the risk inherent in holding lots of company-owned stock are the well-known corporate catastrophes such as Enron, WorldCom, Bear Stearns, and MF Global. It doesn’t make sense to tie too much of your current income (your job) and your future wealth (your stock) to the performance of one company. 

Out of curiosity, I looked at the Employee Benefits Research Institute’s study, 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2009. (The study looks at 401(k) plans and not Employee Stock Purchase Plans.) It shows that average asset allocation in company stock in a 401(k) plan is down from 19 percent in 1999 to 9 percent in 2009. It’s a healthy trend.  

What would I do in your circumstances? I would opportunistically diversify your stock portfolio, whether you use the money to slash the cost of buying a car or not. (By the way, taxes can be complicated with an Employee Stock Purchase Plan. Plan administrators usually provide the figures you’ll need to calculate the tax implications at sale.) 

Full disclosure: I almost always lean toward keeping options open while protecting against downside risk. So, you’re going to take a big chunk of savings to pay for the car. I think it makes sense to pay for the remainder with OPM — Other People’s Money — for now. As you say, you won’t pay much in interest. You buy time to rebuild savings. You maintain your financial flexibility. Yet the downside risk is limited since there’s no prepayment penalty with auto loans. You can always pay off the loan if that turns out to be the smart move.

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