"Should I Borrow To Buy Something that Depreciates?"


DougMaly.com
12OCT2020

archer

From: "Business Course I" by Gary North
Lesson 45

Cost and Benefit

Should you take on debt for a depreciating asset? Consider if you should take action to change your life to a new state.

Perform a cost/benefit analysis. Is the benefit (asset) worth the cost (debt)? Since all value is subjective, a universal answer does not exist.

Example

Taking a specific example, suppose you live in the rural U.S. and you can not even purchase groceries without a car. You could find a solution – such as moving to town – but otherwise a car is a necessity. You might think that you need a car at any cost.

In General

For the case in general, let's consider the objective information. The cost of your new "state" is

  1. you are in debt to someone else, and
  2. you must pay extra money (interest).

The benefit is the new, depreciating asset.

This condition exists over the life of the loan. After the debt is paid, you are left with the asset. At that point your total cost is the original value of the loan (principal) plus the interest.

In the meantime, your asset is worth less by definition.

Clearly the total cost is more than the original price, or the principal of the loan. The benefit is less than the price.

Conclusion

The benefit is not worth the cost. You should not borrow to buy something that depreciates.

Wealth and Value

Finally, let's revisit the question of subjective value. Suppose you need a car (depreciating asset) out in the countryside. You literally can not eat without owning a car. Or so you think.

It may be in your interest to take out a car loan in order to buy groceries, take your children to baseball practice, and drive to work for the paycheck you need to service that loan. You may think it is in your interest to take on the debt in order to drive to classes and improve your future earning power.

This may be true. If you determine the value is greater than the costs of indebtedness, interest, and depreciation, then it is true for you.

Nevertheless, note that if you make a strong determination, there is always a way to stay out of debt. If you value freedom from debt enough, you may have to make unpalatable sacrifices, but you can find a way.

archer


d.maly@ieee.org