Purchasing a car is the second biggest spending decision we face as consumers next to buying a home. Unlike real estate or an investment portfolio which appreciates, cars are rapidly depreciating assets. In addition to the car’s sticker price, operating expenses can drive the unsuspecting consumer into the poorhouse. And, if you choose to finance your car purchase, your losses will be compounded.
For most, owning a car is a necessity. And, aside from riding a bike, there are few ways to steer clear of the ongoing operating costs. You can strive to minimize them by applying a few common sense rules of thumb and by planning ahead for the next car purchase.
The day you purchase a new car it immediately loses much of its value. By the time you ultimately sell it, you will have lost most of your initial purchase expense. With the operation, maintenance, and repair bills, the outlay becomes even larger. Not only do you pay a substantial amount to own a car, but you are forgoing the opportunity to save and invest this money in appreciating assets.
Economists call the alternatives of what you could have done with your money your “opportunity costs.” A single car purchase can cost you hundreds of thousands of dollars of opportunity costs.
Consider this simple example: You buy a car for $20,000 and keep it for five years. During that time, you fork over $5,000 for loan interest, $800 per year for insurance, $200 per month for gas, and $500 per year for maintenance. The operating costs alone will cost you $23,500. After five years, your car has a resale value of $10,000 (if you’re lucky) and you’ve spent $23,500 to keep the car running for a grand total of $33,500. But, that’s still not the total cost for owning the car.
Had you invested your expense of $33,500 in an asset that appreciated an average of 10% per year, at the end of five years you would have $53,950. So, not only did the $20,000 car have direct costs of $33,500 but you lost out on the potential to earn an additional $20,450 by investing that money instead. This brings your total opportunity cost for owning a $20,000 car for five years to a whopping $53,950 [$33,500 + $20,450]. Every new car you own depletes your retirement nest egg and delays a comfortable retirement by years.
It is possible to avoid driving a wreck without wrecking your finances. I’ve known couples with little to no retirement savings that justify buying $30,000 cars because they will get better gas mileage. To others, a car is not just a means of transportation, it is a lifestyle. You need to be more mature and consider the long-term effect on your finances.
When you buy a car, it’s best to buy a used car that is two to four years old and has less than 50,000 miles on it. By this time the most rapid depreciation has already occurred, but it should still have enough useful years left to keep your annual maintenance costs low. Aim for the least expensive car that you can tolerate to drive.
Only buy a car you can pay for with cash. Shun easy credit. The only thing worse than buying a depreciating asset is buying a depreciating asset on credit. Paying interest on an asset that goes down in value is a ticket to the poorhouse.
Start saving for your next car immediately after you’ve purchased your current one. Put the money you are saving to buy a car into investments so that they can grow. Drive your current car as long as it is safe and reliable. The difference in your finances will be significant. Eventually you will have thousands of extra dollars allowing you to buy whatever car you desire from the annual investment return alone.
Leasing a car does not help very much. When you lease, you are essentially paying for the car’s depreciation plus interest during your lease period. Unfortunately, you are still paying for the car’s depreciating during the steepest drop in the car’s value. There are some cases where you can take advantage of leasing as a business owner for tax purposes, but for the most part, leasing is a more expensive way to finance a car than paying all cash.
You can also minimize the cost of owning a car by reducing your insurance premiums. Get insurance quotes from at least four or five companies. You’ll be surprised at how much premiums vary between providers. Also consider keeping a high deductible such as $500 or even $1,000 and dropping the collision and/or comprehensive portion of your coverage if your car is old and not worth more than a few thousand dollars.
On-line consumer resources such as www.edmunds.com and www.carfax.com can help guide you through the car-buying process. The more informed you are prior to entering into your purchase transaction, the more you will be able to stay within your established budget.
Because of the time value of money and the power of compounding, you should think of all of your major purchases in terms of your total opportunity costs. This is a good way to avoid overspending. The less you spend on depreciating assets, the more you can save and invest in assets that should grow in value and help you meet your long-term financial goals. Secure your financial security before you secure your dream car. And analyze all your major purchases within the context of a comprehensive plan for saving and investing.
Photo by Benjamin Child on Unsplash. This post was co-authored by Justin Harris.