Are You About to Commit Vehicular Budget-cide?

The Simple Choice of What Kind of Car You Drive Can

End Up Costing You Millions—or Making You a Millionaire

By Mark D. Wolfinger

t’s top-down convertible weather, and there’s plenty to celebrate. You’ve just graduated, and even in these tough economic times, you were lucky enough to land the job you really wanted.  Finally, you’re going to have money to spend and a new place to live. Best of all, you promised yourself that once you got your first job you’d get yourself a new car to go along with it. You’ve driven that beat-up old Chevy long enough. It’s time for one of those sexy little Miata’s—or a Beemer, or a Lexus, or a Saab. You have a job with a good income—why not?

          Okay.  Take a deep breath.  Buying a new car is certainly something to look forward to. But do you know what your monthly payments will be?  Are you forgetting about your college loans? Do you really want to tie up money that could be going towards a mortgage down payment, or your kids’ college education years from now? “Wait a minute, I’m not even married,” you’re probably thinking, so how can my first car purchase jeopardize my kids’ college tuition? Believe it or not, the car-buying decision you are about to make will have a major impact on the rest of your financial life. 

The True Cost of Hot Wheels

           Let’s crunch some numbers. You’ll quickly see why it pays to carefully consider your options before buying a new car. 

Assumptions

·       You have very little accumulated savings and are making a minimum down payment (10 percent).  Your trusty old car is worth another $1,000 as a trade-in.

·     The car loan is for four years at six percent interest.

·     Retirement is 45 years in the future.

·       You plan to buy another car in four years.

·      The cost of insurance, gas and maintenance are ignored for this discussion.

Your Choices

          Spend $30,000 to buy that sexy car of your dreams—a BMW 325 Coupe, an Infiniti G35 Sedan, or maybe a Nissan Pathfinder SUV—as a graduation present for yourself.

          Spend $10,000 to buy a modest new car or a better-quality used car as a graduation present to your future.

The Money

          If you buy your dream car, you’ll have the pleasure of driving that car for four years.  When those four years have passed and you are ready to buy another car, your finances will look like this:

·        Car loan paid in full.  Cost: $611/month.

·        Your current car’s trade-in value is $9,000.

·        Savings: None.

         If you buy the much less costly new or used car, your finances will look like this:

·         Car loan paid in full. Cost: $189/month ($422 per month less than the flashier car).

·        Your current car’s trade-in value is $3,000.

·        Savings: You invested the $422 difference in a savings account paying three percent interest, and you’ve accumulated $24,316.

·        You use $7,824 (plus trade-in) of that amount to pay cash for another used car and invest the remainder in a retirement account (taxes are deferred, so you must pay them later).

·        Maintaining the account for 41 years (until retirement), you will have $386,930, if your investments grow at eight percent per year, and $821,029, if your investments grow at 10 percent per year.

         That flashy new car is beginning to look a lot more expensive than you thought, isn’t it?

Deja Vu All Over Again?

         Now, instead of trading up with your second car, let’s see what happens if you choose another used or low-cost car. Passing up the hotrod of your dreams a second time and purchasing your second car with cash allows you to now allocate the full $611 towards savings. That means that in another four years’ time, you will accumulate $35,122.  If this amount is invested in a retirement account (this time for 37 years), you will accumulate an additional $605,714 by the time you retire, if your savings grows at eight percent; and an additional $1,194,312, if your savings grows at 10 percent.

         Adding up our accumulated savings over time, if you choose to purchase an inexpensive car just twice in the first eight years of your working life, you can reasonably expect to have a grand total of the following amounts saved by the time you retire, depending on the return on investment your savings earns:

·        $992,644, if your savings grow at 8 percent

·        $2,015,341, if your savings grow at 10 percent.

         (Note: Earning eight to 10 percent compounded annual interest over the next 41 years is a reasonable expectation, based on past performance of the American stock market.  Although the performance of the last few years may be disconcerting, there have been other periods of either substantial market decline or market stagnation in the past. But, even within those periods, a more than 10 percent average return has been achieved.)

         One to two million dollars may not be enough for you to live out your retirement in comfort, but it will certainly make a huge contribution towards that goal.  And the only thing you have to give up is the fun and excitement of driving a flashy car for eight years.  Given the upside of downsizing your auto fantasies, it might be wise to use your imagination—pretend you’re driving a Mercedes when you’re behind the wheel of your Ford. It’s worth it! 

         It’s not easy to defer instant gratification.  You may see your friends driving cars that you lust after. You’re going to be constantly bombarded by advertisers who want your money. Just keep your eye on that money growing in your retirement fund, instead of on the roadster of your dreams. The younger you are when you begin saving, the greater your accumulated wealth will be.  Don’t fool yourself into believing that you can accomplish the same thing by starting later in life. A delay of just four years will reduce your expectations by $263,000 (8 percent growth) to $639,000 (10 percent growth).

          Most of us never consider the consequences of our shopping choices; in this credit-driven society, we’re conditioned to buy what we want when we want it, even if we can’t afford it. Cars aren’t the only purchase where this rule of wait and save applies. It’s financially foolish to go into debt to buy anything that depreciates in value, and cars lose their value the minute you drive them off the lot. You’re only young once and it’s important to enjoy yourself.  Don’t deny yourself pleasures that are within your means.  But future millionaires know the importance of taking the total cost of every expenditure into consideration; they don’t go into debt to satisfy their need for instant gratification or to keep up with the neighbors (who may not be as financially literate).

          “You aren’t what you drive,” say Thomas Stanley and William Danko, the authors of “The Millionaire Next Door.”  If you still want that Lexus when you’re older, rest assured a newer, snazzier model will always be waiting in a car showroom near you—and by that time you may even be able to pay cash for it.

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      Mark D. Wolfinger is the author of “The Short Book on Options: A Conservative Strategy for the Buy and Hold Investor.” He has been in the options business since 1977, working primarily as a market maker on the trading floor of the Chicago Board Options Exchange (CBOE). Mark currently gives seminars on the subject of stock options. He drives a 1992 Mazda with 90,000 miles on it and can be reached at mark@mdwoptions.com