Tuesday, April 12, 2016

If it's too good to be true, something's wrong



DURING a recent shopping session with my family, I saw an interesting promotion for a television set at a big retail store.

The retail price for the said television set was RM4,999. A 22% discount was offered for cash purchasers which brought the price down to RM3,899.

While the price seemed attractive enough, I saw another sweetener for the deal, stating that the special price under its flexible payment plan was RM2,729.30, apparently a massive 45% discount from the retail price!

At first glance, the flexible payment plan was the best deal. As the deal seemed too good to be true, I decided to do some calculation to see the rationale behind it.

Under the flexible payment plan, the weekly installment was RM26.72 for a total of 5 years.

The price of the television set would end up to be RM6,947 instead of RM2,729 upon the last payment.

I was surprised with the huge difference between a cash purchase and the flexible payment plan. This incident has also highlighted some blind spots we have in our spending.

Many a time, there are instalment plans that offer seemingly low interest rates as their marketing strategy.

As consumers, we may end up spending more than we thought if the effective interest rate and other financial concerns are not taken into account.

Taking the television set as an example, the total amount paid for the instalment plan is 78% higher than the cash purchase.

The effective interest rate per year for the financing of 5 years is about 45%, which is way higher than our fixed deposit rate of only 4%.

Bear in mind the high amount that we pay is for a depreciating item. With more advanced technology introduced year after year, the television set we buy today would not have much value left.

Thus, what looks like an attractive deal initially does not ring true anymore after factoring in high effective interest rates and accelerated depreciation in values.

Looking at the high premium charged for the instalment plan, it would be better to go for a cash purchase if the situation permits.

Often, it is better to evaluate our needs before making the decision to purchase depreciating items.

I always encourage prudent spending especially in testing times when we are faced with uncertainty in the economic environment.

Imagine if we can channel the money spent on depreciating items to assets such as investments or properties for the same period of 5 years.

Our money would have grown and helped to improve our financial position, or at least to hedge against inflation.

Other than potential value appreciation, the interest we pay for a housing loan is lower compared to other loans such as personal, credit card and car loans.

The effective rate for a housing loan is as advertised, and the rate is calculated based on the reducing balance (only pay interest on the remaining loan balance).

On the other hand, for car loans and flexible payment plans like the one mentioned above, their interest rates are calculated based on the full loan amount throughout the term, which makes the actual interest rate higher than the advertised rate.

For instance, the interest rate for credit cards is calculated based on 1.5% per month, hence the effective rate per year is 18% (1.5% times 12 months).

On the other hand, for a RM100,000 car loan with a 2.5% interest rate and a 7-year loan tenure, the interest amount would be RM17,500, making the total amount for the car RM117,500.

As a result, the effective interest rate for this car loan is 4.7% instead of 2.5%.

On many occasions, we tend to be drawn in by the “attractiveness” of easy payment plans without weighing the hidden financial commitments.

Though it helps us to obtain an item immediately, we may overlook the true value of the item and the potential financial burden it brings.

Therefore, if a deal is too good to be true, most of the time, it is just too good to be true and worth a second thought.

By Alan Tong food for thought

Datuk Alan Tong was the world president of FIABCI International for 2005/2006 and awarded the Property Man of the Year 2010 at FIABCI Malaysia Property Award. He is also the group chairman of Bukit Kiara Properties. For feedback, please email feedback@fiabci-asiapacific.com.

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