There are few Americans who can save $30,000 in five years, but anyone who buys and finances a new car could be doing exactly that. Maybe it's time to consider what you're really giving up when you buy something expensive with borrowed money.
I’m 54 years old and have yet to own my first new car. In this article and the next, I’m going to explain why I never buy new and show you exactly how to find a $5,000 car.
When I graduated from the University of Arizona in 1977, my parents gave me a 1975 Toyota as a graduation present. Much to my parent’s dismay, however, within a few weeks I’d sold that car and used the proceeds for the down payment on my first house: a 900 square foot concrete box in a dicey section of Tucson that I bought for less than $20,000. For wheels, I borrowed a couple of thousand dollars from a credit union and bought a 1958 Triumph TR3; a car I drove every day for more than a year.
While I did ultimately sell both house and car for a profit, the point of this little story is that the way you approach cars, houses, saving and investing is really limited only by your imagination. And most people don’t seem to have much.
When it comes to buying cars, the vast majority of people I’ve known over the years approach the subject with no imagination at all. They simply do what the commercials tell them to and what their friends do: trudge down to the nearest dealer and buy a new car. If they want to feel like informed consumers, they comparison shop, kick a few tires and talk to a few salespeople in an attempt to get a decent deal. But even if they drive the hardest possible bargain, that new car is still guaranteed to lose thousands of dollars in value before they can get it home.
And that’s especially true if they pay interest by either financing that car or leasing it. Paying interest to finance a depreciating asset is not how you get rich. In fact, with the possible exception of gambling, it’s one of the fastest ways to get poor.
I’ve explained this concept several times during my TV news career and written about it in books.
Check out the following news story I did about opportunity cost and new cars, then meet me on the other side for more.
So the point of this story is that when you buy a new car with $5,000 down and make $400 monthly payments for five years, your opportunity cost is about 30 grand: money you could have had if you’d earned 9% rather than paying it.
Whenever I run an example like this, I invariably and understandably get responses like this: “I can get a car loan for less than 9%.” And “Please tell me where I can earn 9% on my savings!” Both statements are valid. I used 9% in my story because it better serves to illustrate the point: paying less, or earning less interest, would indeed lower the $30,000 opportunity cost of owning a new car.
That being said, however, there certainly are people who pay more than 9% on a car loan: plenty of them. There are also plenty of people who can and do earn more than 9% on their savings: the stock market has averaged about that much over the last hundred years or so. Although, it didn’t do that for the first 10 years of this century and has never done it without risk.
Bottom line? The next time you’re thinking about shelling out for something really expensive… especially if payments are involved, don’t just consider the cost. Consider the opportunity cost: the money you could have made by putting those payments somewhere else. Then think about ways to make more on your savings and to spend less on life’s major expenses, like cars.
Speaking of which, understanding opportunity cost is only half this story. Tomorrow, I’ll post the next part where I go over the details of finding and buying a $5,000 car.