Should You Buy a New Car Because You Can?
BY PETER GAERTNER
Understanding the time value of money when considering buying a new car.
Not a day goes by that I don’t get in or out of my 2012 Subaru Forester without thinking about “upgrading” to a newer model. Less mileage, better safety features, cutting-edge technology and of course that new car smell! Don’t get me wrong, I love the reliability of the crossover but what young professional doesn’t fantasize about driving the Ultimate German Driving Machine – especially when you were born in Germany!?
Then again, I rarely spend more than 2 hours a day in my car and use it primarily to drop off my kids at school and get to work and back home. Every few weeks, I will spend more time and miles in and on my car for away or out of state meetings but any time we take trips with the kids, we take the family minivan. I bought this car 5 years ago when it was already 3 years old with 35,000 miles on it. Five years later, I am at 85,000 miles and no issues or major repairs that were required except for new tires. One might say that I am about due for some hefty and healthy repairs and that this may be a good time to consider trading it in and replacing it with a new, or slightly used car, to avoid the expensive headaches down the road.
Unfortunately, as with many things in life, there is no one-size-fits-all answer. But I will share my opinion and preferences with you and hope it resonates with you as well at least when it comes to the numbers because, let’s face it that’s what I enjoy and obsess over.
When it comes to cars, I am a firm believer that there is no car cheaper than the one you currently drive and that’s, ideally, paid off. The average car or what seems to be popular these days, SUV, costs around $35,000 for the models I follow such as a slightly used Subaru Ascent. After trading in my current vehicle plus transfer and tax fees, let’s say the difference is a round $25,000 to keep the calculations easy. Unless you are buying a classic car, I would also argue that the value will go down the moment you take ownership and you leave the dealer’s lot.
Now, you could pay cash for this big purchase. These funds could come from savings, investments or similar and may or may not have a big tax implication. However, you are sacrificing the possibility of having $25,000 invested for years to come, funding a retirement account and/or may not have this type of cash cushion available.
You could take out a car loan from the dealership, bank or other financial service provider. Let’s say, best case scenario, you get a 0% loan for 5 years, that’s $416.67/month for a car payment for the next 5 years.
Another option would of course be leasing the vehicle of your dreams, but I will not go into that today. It may make sense for some people or for business purposes, but personally, I like to own what I drive.
Now, let’s look from a financial professional’s point of view how each of these choices would play out over the next 30 years if we invested these funds instead:
$25,000 invested immediately, no additions, no distributions over 30 years earning an average of 7% annualized would provide a future available balance in 2050 in the amount of $190,306.38.
$5,000 a year invested for years 1-5 and no additional contributions or distribution for another 25 years also assuming a 7% annualized return would result in $156,058.77.
Now, while we would likely give up more of an opportunity cost on option #1 when compared to #2, both choices are superior to spending the $25,000 on, yes, an asset. But no, it’s not growing for you and will probably be worth less than half of the purchase price when the time comes to sell it, so let’s not call our cars an investment unless you have a classic tag on it.
The reality is, most of us will end up buying a new or used car every so often and that’s okay. We do have to get from point A to B safely, especially when there is precious cargo on board, or the car is necessary to earn more money. What I want to challenge you on and hope that you realize after some very basic examples above, is the power of compound interest and related opportunity cost. Of course, the salespeople in the dealership will make it sound like they are giving you the deal of a lifetime, low payments, no interest, special promotion, family and friends discounts, you name it, they got it.
Take a step back, run the numbers, or even better, let us run the numbers for you and compare your options to help you make a sound financial decision as part of your overall financial strategy for years to come and allow for you to live your best life possible. As for me, I will settle for buying a bottle of that “New Car Smell” spray instead!