So, your sofa is looking pretty nasty. Its covered with Kool-Aid stains,and throw pillows are hiding threadbare spots where the tufting peeks through. You even had to throw down some plywood to keep the pillows from sagging. Time to go out and buy a new one, right? Not if you dont have the cash. Heres why that new sofa is going to cost you a lot more than the $800 sticker price if you go into debt for it. Lets assume you buy the sofa as well as matching loveseat and end tables for a grand total of $2000. You finance your purchase through the furniture store for three years at an interest rate of 21.45% (lets leave out the no interest for two years deal for a minute). Your monthly payments will bedrum roll, please$75. Wow, you think. Thats pretty affordable. Sure it is. Until you count the true cost of that sofa. Lets assume youre 30 years old and youre going to retire at 65. Lets also assume you have access to a 401(k) that your employer matches at 50%, you can earn a 10% average return on investments, and your combined federal and state tax brackets are 20%. If you pay for your furniture with cash and invest the $75 a month in your 401(k) for three years instead, youd have $4,330 more in your account at the end of the three years (plus your sofa). Now keep that $4,330 in your 401(k) without any additional investment and in another 32 years, at retirement, it will have grown to $83,112. So, basically, your sofa cost you $2,000, plus $700 interest, plus $83,112 that would have grown over 32 years in your retirement account. Final sticker price: $85,812. Yikes. Heres an alternative plan: hang on for another two years, save $80 a month in a money market mutual fund or savings vehicle that earns at least 4%, and use cash to pay for your new living room set. Final sticker price: $1,920 Heres an even better alternative plan: hang on for another two years, save $80 a month, and after you buy the sofa, put $80 a month in your 401(k) instead (you were already living without it for two years). Final sticker price: $1,920, plus an extra $815,699 in YOUR bank account by age 65. Now what about those no interest for two years deals? Well, you can certainly take advantage of those, if youre disciplined enough to pay off the balance in less time. Most people arent. You can use this strategy for every major purchase you make. The cost of debt is a big deal, when its compounded by time, interest and 50% employer matching. So next time you hit the furniture store and the salesman is telling you, Its only going to cost you $75 a monthyoull know better. Tell him or her, Nope! Its actually going to cost me around $800,000. See you in two years. |
