I am always amazed by the people who drive a new car every few years while they earn an average income. In 2018, a brand new car in the United States had an average sticker price of $35,000 and the median income was $61,000. You can argue that some people can afford it and that would be correct. But very few individuals are disciplined enough to save that kind of money. I know this because the auto loans in this country has climbed to $1.1 trillion dollars according to Kelley Blue Book.
A lot of new and fancy cars you see on the road are financed. A $35,000 loan will require you to pay around $400 per month. That is a lot of money just to get yourself to work in a shiny set of wheels. And that is just the cost of the loan and interest. If you add the cost of insurance ($100/month for full coverage) and fuel (assuming $50 per week), you would be spending close to $700 per month. If you add depreciation (assuming $200/month), the car will be costing you almost $900 per month or more. If we include maintenance, let’s assume $100/month, the cost of ownership will be as high as a $1,000 per month.
At an average cost of $1000 per month, the annual cost of ownership would be $12,000. If you pay off the car in 4 years, it will end up costing around $48,000. But I have seen loans that go for 60 months and up to 72 months. A six year loan will cost more than $70,000 dollars.
Opportunity cost is a hidden cost of car ownership. A lot of us do not take opportunity cost into consideration when we buy depreciating assets such as cars. Opportunity cost is more of a trade off. Every decision you make means that you’re accepting one option and giving up on other possibilities. In this case, you are choosing a new car vs investing. So, let us look at the three scenarios below that illustrate the opportunity cost of opting for a new car instead of investing.
Scenario 1: If you invest $35,000 for 10 years with an average return of 7%, the end result would be $68,000. Now let say you invest the $35k, then contribute $200/month (just the price of depreciation at $200/month), in 10 years your portfolio would grow to $103,000. I excluded other costs of running the car in those 10 years since an old car will require maintenance, fuel, and insurance but might not depreciate as much.
Scenario 2: Now let us assume you bought a 10 year old Honda Civic for $5000 cash, and insurance is still $100/month, maintenance is $200/month, and fuel stays at $200/month. The total monthly cost to operate the car is around $500/month. Compared to a financed new car, you’re saving $500/month. If you start investing the difference, just $500/month for 10 years and 7% APR, you would end up with $86,000.
Scenario 3: If you had $35,000 cash for a car but you decide to buy a $5000 Honda Civic, and invested the remaining $30k, you would have made a great decision. You would have a car that have hit the bottom of the depreciation curve and $30k initial investment. If we assume the cost of running the old car stays the same at $500/month, you would have an extra $500 to invest compared to financing a new car. If you invest $30k plus $500/month at 7% APR for 10 years, you would end up with $144,000.
That is how a $35,000 car can end up costing you over $100k in 10 years. You can argue for cheaper running cost per month but the reality is cars are expensive. They cost more to own than we would like to admit. To make the matter worse, buyers are opting for more expensive trucks and SUVs instead of cheaper economical cars. Some people might say old cars are unsafe or unrealiable and they might have a valid point. But in the end, it is about trade offs; it is about choices that we are willing to justify.
In 10 years, which one would you rather have, An investment account with $100k or a car that have lost 75% of its value?
Next time you see someone driving a brand new car, don’t be envious; they could be driving their retirement account. Invest in your future and learn to delay instant gratification.
Drive safe and do not drive your bank account.
Thank you for reading.
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