Thursday, March 15, 2007

Car Cost Savings

Its easy to fall into what I call the "If only I had 20 % more trap". We are continually bombarded with advertisements aimed at selling us on the idea that having more is better. We are told, at great expense, that if we buy a newer car or a faster computer or whatever, this will magically bring us instant happiness.

For a long time I have always driven an older car as a main family car, and our second car was older yet! I find that most everyone I know has always driven newer cars than me. This includes young adults and grandmothers. I have never had a car let me down when I was away from home. I'm not a mechanic, I just know how to do a few simple things.

I have been motivated by the savings between owning a newer and old car. Consider the following example.

The largest cost of a newer car is the depreciation. A new car depreciates 30 percent in the first year and 20 percent for every year thereafter. For example, a $30,000 vehicle depreciates $9,000 or $25 per day during the first year. If we add in a sum for opportunity cost (lost investment dollars) or the cost of a car loan, at a rate of 4 percent, this comes to an additional $3.25 per day. A total of $28.25 per day.

Now to be fair, we need to subtract the cost of a less expensive car alternative. I will use $15,000 for a used car about 5 years old. Depreciation at 20 percent is $3,000 per year or $8 per day. Opportunity cost at 4 % adds $600 per year or $1.65 per day for a total of $9.86 per day. I will also throw in $500 for maintenance over and above the cost of maintenance for a new car, another $1.37 per day bringing the total to $11.25 per day.

The incremental cost for owning a new car in the first year is then about $28-$11 or $17.00 dollars per day. Now this difference drops off each year if you keep the car for many years. Its more extreme if you lease a car and change every few years.

To put this into in a more meaningful perspective, what if you saved only $10 per day on average for 25 years during your working career? How much would you have at retirement?

That $10 per day comes to $3,650.00 saved each year. If you earned 5 % per year on this savings it would grow to $174,000.00. That's not a bad lump sum payment for forgoing the benefits of owning a new car. You don't have to drive a wreck, just something mid-range. You can think of it as creating your own retirement allowance.

Reference: Future Value of an Annuity

Driving an older car can save you money today, get you to retirement sooner, and reduce your expenses during retirement.


Anonymous said...

Great post CM!

the money diva said...

They say that the best car strategy is to buy new (or perhaps a couple years old) and drive it till it dies. I bought my last car 3 years old and drove it for 10 years. The last 7 years without car payments sure were nice. And at the end of it, the car was still worth about 30-35% of what I bought it for so my total annual cost was very low.

It's a bit of a shock to pay for the new car, which I bought 6 months old. Actually, I took over a lease, which I didn't really want to do, but the deal was too good to pass up.

A new car is a nice treat. But no one needs a treat every day or you get cavities. :)

S. B. said...

Cars are a big money sink. Fortunately, I have always been the type of person who could care less what kind of car I drive. I just need it to get me wherever I'm going. (Ah...if only I could be so indifferent with other items!)

In 1997, I purchased a 10-year old vehicle for $3,250. I am still driving it to work! My car is now old enough to vote and go to college!

I always enter the fair market value of my cars into Quicken and then adjust the FMV once a year. This helps reinforce the depreciation in your mind as it shows up as an expense in your finances. This is probably overkill for most people. As long as you're cognizant of the depreciation, that's really all that matters. But for me, watching each depreciating asset drop in value in Quicken reminds me that depreciation is a real cost.

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