The "cheap money" argument has a flaw

I talk to a lot of people about their money. Seriously, a lot of people. So at some point, I begin to hear the same things over and over. "Cheap money" is one of the phrases I hear often. If you aren't familiar with this concept, get ready, it's messy.

This week I met a guy who was probably no older than 30 and had $35,000 in his checking account, a car loan, and hundreds of thousands of dollars in his 401(k). Based on these three facts alone, this guy gets a B+ for his personal finances. And since I can't remember this guys name we'll go with B+ Guy. Why not?

Before I get to the point, I have to address the $35,000 in his checking account. You know how I feel about bloated checking accounts. They are just asking to be spent. Think of it this way, if you had a prepaid credit card loaded with $35,000 on it, would you spend more than usual? The answer is yes. It's human nature. Also, keeping this much money in a checking account is setting yourself up for identity theft. You may be thinking the missing piece to my argument is if he had the discipline to accumulate all that money, he is unlikely to be a big spender. But here's the thing, he didn't accumulate this money through saving $500 a month for the last 6 years. No, this money is a combination of bonuses and tax refunds. We'll address this again in a minute, but let's move on to the main point.

My meltdown came when he told me he didn't pay cash for his car because he was able to borrow the money for the car at 1.9% interest, therefore it was "cheap money". Sigh. I understand his point. Borrowing money at 1.9% compared to 6% does, in fact, make it "cheaper" but the whole theory of cheap money is more about the cash. It's only really cheap money if you do something better with the money you're not using to pay cash for the car. It doesn't make sense to pay any interest, however, small the amount, if the cash you could have used to buy the car isn't gaining its own interest. The interest rate of the loan has to be relative to what rate of return you are receiving on other funds. Of course, don't go out and borrow money to invest it, that's a dangerous game. My issue is more that B+ Guy's cash is just sitting in a checking account earning nothing. If he had told me the money he could have used for the car was earning an average of 6% each year, okay then, fine, good for him. But it wasn't, so his "cheap money" idea didn't quite play out.

When I recommended B+ Guy at least move $30,000 to a savings account he said he didn't want to do that because he wouldn't earn enough interest in a savings account. You can't see me, but I'm shaking my head.

My whole point isn't to crucify this guy because he's clearly doing a lot right. I'm using him to show how misguided the idea of "cheap money" can be. If you have cash to pay for something use it, unless you are able to use the cash to make more annually than you pay in interest on your loan.

To hear me explain this concept as well as more details about B+ Guy, listen to this segment from The Pete the Planner Radio Show on WIBC