Hey everyone! The title of this post is supposed to be a little humorous….the joke being that your car will get better gas mileage if it isn’t being loaded down by those HUGE monthly payments! But all joking aside, car payments are NEVER a good idea. I would rather ride a bike everywhere I needed to go before signing up for a car payment. Let me show you why.
THE MATH SUCKS
According to Edmunds.com, the average car payment in America is $479 per month. Over the past few years, auto loan terms have substantially increased from an average of 60 months to 73 months and longer. For those who are not trained accountants, an important concept to understand is the time value of money.
I’m a simple guy, so I like to break down complex topics in order to more easily understand them. The time value of money can best be stated as, “A dollar today is worth more than a dollar tomorrow.” The reason this is true is because if you had a dollar today, you’d be able to invest it in order to make money.
Think of a simple savings account you may have at the bank. If you invest one dollar and earn 1.0%, at the end of the year you’d have $1.01 (more than $1). Check out this post if you want to learn more about compound interest and how fast money invested today will grow to much more!
Applying this concept to auto loans, if you were to invest $479 in a growth stock mutual fund (which I recommend) from age 25 to age 65 and that mutual fund averaged a 12% annual rate of return, you would have $5,635,326! For those of you who live by the mantra, “I’ll always have a car payment,” I hope you like the freaking car because your car payments are costing you millions!
I read some research a little while ago that showed that people who are wealthy tend to have a long-term planning window, whereas people who are broke usually have a short-term mentality related to financial decisions. So the key question to ask here is, “What is the 20, 30, or 40 year implication of making car payments?” The answer is millions of lost dollars. Sure, the $479 monthly car payment doesn’t seem that difficult to make each month (short-term thinking), but it certainly costs you in the long run.
DEPRECIATION VS APPRECIATION
It’s no surprise that cars go DOWN in value over time. In fact, most things with motors lose value. Wealthy people recognize this and tend to buy cars that are two to three years old. Why you may ask? On average, a new car will lose about 40% of its value in the first four years, with almost 20% lost in the first year. Yes, the saying that a new car is worth less the minute you drive it off the lot is very true.
A good rule of thumb to use when analyzing your situation is to add up all of the things you own with motors and compare that amount to your annual household income. Typically, you wouldn’t want this percentage to be more than 50% of your annual household income.
So if John and Marie make $50,000 per year, they wouldn’t want the total of all their cars, motorcycles, boats, etc. to be more than $25,000. The idea is that you have too much invested in things going down in value if you have more than half of your annual income tied up in things depreciating rapidly. The obvious goal is to invest in things that go UP in value over time (real estate, mutual funds).
MY OWN PERSONAL LESSON ON DEPRECIATION
Now for a little personal info. I’m a guy, so naturally I love cars (and anything with a motor for that matter!) Growing up, my dad taught me how to work on cars. He was an aircraft mechanic in the Air Force. The skills he acquired while working on airplanes transitioned very well to the auto mechanic world.
That being said, we never really had NICE cars. You know the brands that come to mind when you think of nice cars…BMW, Mercedez, Lexus, Audi. My first car in 2002 was a white 1992 Plymouth Acclaim. We always drove much older cars. Over the years, I learned how to keep these older cars running by changing the oil & filter, spark plugs, transmission fluid & filter, air filter, and brake pads and rotors. Mostly basic stuff, nothing overly complicated.
I think I’m pretty handy with cars so I don’t hesitate to purchase an older car with higher mileage provided it has been maintained well. Fast forward to 2013. After driving these older cars for so long, I thought it was time to upgrade. And upgrade I did. I saved up enough cash to purchase a 2006 BMW 750i for $17,500. I also owned a 2004 Dodge Ram 1500 that was worth about $6,000. Both are pictured below.
And so my lesson on depreciation began. Of course, I learned about depreciation when studying accounting. But this was a real-life experience! I drove the car for about a year and put minimal miles on it. Parts and repairs were very expensive, of course, since it was a BMW. I ended up selling the car for $9,500 about one year after I bought it. Talk about loss in value! Who would have thought BMWs also drop in value?
The only smart parts of the BMW deal were that I paid cash and the total of all things with a motor that I owned was less than 50% of my annual income. Had I financed this very same car, I would have been in a world of hurt!
WHAT I DRIVE NOW
The BMW lesson taught me that depreciation is very real. While I still love cars (BMWs included), I also learned that I needed to prioritize the more important things like saving for retirement and cash-flowing a wedding (yes, this was the main reason I decided to sell the BMW). It was just not the right time for me to have that much money invested in vehicles.
The same applies at this point in my life also. My wife and I are in the process of buying a house and starting a family. So now I’m the proud owner of a 2003 Ford Expedition with 225,000 miles and a 2004 Infiniti I35 with 135,000 miles that I was able to negotiate great deals on by paying cash. My wife drives a 2005 Cadillac SRX with 80,000 miles (also paid cash). I love to go surf fishing, so I mainly use the Expedition on the beach, whereas the Infiniti is my commuter car since it gets pretty good gas mileage. It’s no BMW, but I’m not complaining. Sure we could go out and finance two brand new BMWs today, but that would only hinder our future financial goals. Drive some older cars now, and later, you’ll get to drive whatever you want!