Sunday, May 19, 2013

Lesson 7: New Cars vs. Used Cars

Financial Planning for the Recent Graduate

If your financial advisor told you to invest $30,000 in a stock that lost 9% as soon as you bought it, lost 20% in the first year, and would be worth less than $15,000 (half of its original value) by the 5th year, would you buy it?  Of course you wouldn't, but this scenario happens every time we buy a new car.  As soon as you drive it off the lot, your $30,000 new car is now worth $27,314.  You just threw away $2,559.  Is that new car smell really that worth it?  

It's time to get emotionally mature with our purchases.  You don't need that new car.  Here's why:

#1: Depreciation.  A new car is not an investment.  Anything that loses half of its value in 5 years is not an investment.  I love this infographic from, which gives a good visual on a car's average depreciation.  

#2: Monthly payments.  Now there's something you don't want more of: another bill.  Another company who stakes a claim in your paycheck every month.  Oh, and every month that you're paying the car payment, they're tacking on interest, and hoping you'll miss a payment so they can tag you with a late payment fee.  The most profitable person at a car dealership isn't the car salesman, it's the financing representative.  Always remember: Most people ask, "How much per month?", but smart people ask, "How much?"

#3: Higher car insurance: A car that's worth more is a higher risk to insure for your insurance company, so count on higher insurance premiums that you'll be paying every month.

#4: Impressing strangers at a stoplight: Sorry, it has to be said.  You're trying to impress people you'll never meet.  What's the point?

#5: Opportunity cost: Instead of buying that $30,000 car, let's invest that $30,000 in your Roth IRA and don't touch it for 40 years.  With a 9% yearly rate of return, that $30,000 you invested will be worth $1,083,299.07 TAX-FREE.  I hope you enjoy the car!  

I currently own a 1995 Honda Accord with 261,000 miles on it, haven't had A/C in it for about 4 years now, and I plan to drive it until it won't drive any more.  The best part about my car is that I own my car.  My car doesn't own me.  Keep your A to B car as long as you can.  While you're driving your car into the ground, put aside what you would be paying for a car payment into a savings account.  When your car's time has come, don't buy a new car.  Pay cash for a new-to-you car.  There are some great cars out there for $3,000-$4,000.  All you just have to look.  Oh, and if you pay cash for a used car, you've got some serious negotiating power for lowering the purchase price.  Be sure to get the vehicle's history report, so you know what maintenance has (and has not) been done to it, and check out this 10 steps to buying a used car article.  

I want to hear about your A to B car (clunker) in the comments below.  What's your story?

Image courtesy of bDavid Castillo Dominici, image ID: 100148394