One of the major reasons I started this blog is a belief that the number one mistake most people make with their money is with their cars. This is a major problem, as behind the purchase of one’s home, the purchase of a car is the next biggest expense and most families have at least two cars.
In America today people often draw their identity from the car they drive. Some believe they will always have car payments. To prove this as soon or sooner then they have a car paid off, they buy another. The question for them becomes less about what car they can afford and much more about how much the monthly payments are. Believing that if they can afford the payments then they can afford the car.
Society has conditioned many to believe a good car cannot be purchased for cash, at least not the cash they have. To quote Henry Ford, “If you think you can do a thing or think you can’t do a thing, you’re right.” I plan to help dispell the myth that a good cash car cannot be purchased in future posts. In this post, I want to focus on why a cash car is a better choice for one’s future than going into debt for a car.
For the remainder of this post I want to discuss a car purchase with debt versus a car purchased with cash. When it comes to car purchases it doesn’t matter whether you are buying new or used, if you plan to finance a car there is a question you should ask yourself.
Whose bucket am I filling?
Everyday you are filling someone’s bucket, either yours or someone else’s.
Every time you buy on credit you are filling someone else’s bucket with the power of compound interest. This is particularly problematic with cars, as they depreciate. Meaning they lose value.
Let’s look at an example of the power of compounding, I will use an old question, the origin of which I am unsure.
Would you rather receive one million dollars in cash right now or would you rather receive at the end of 31 days a penny with the amount doubled every day?
If you haven’t heard this question, or one like it before, think about it and chose an answer.
Now let’s go through how this works. If you choose the penny compounded on day 5 things aren’t too interesting as you only have 16 cents. On day 15 it looks a little better at $163.84, but it is still a long way from one million dollars. Now we come to day 31. The dollar amount has grown to $10,737,418.24. How can this be you ask? It’s the power of compounding.
We would all like to see our money double every day like the example above. And while this isn’t possible, the power of compounding is at work in your life very day. We all get to decide whether it is working for us or against us.
Let’s now look at two very simplified car buying examples to illustrate.
Car Purchased with Debt:
Let’s look at a new car purchased for $30,000, with $5,000 down and financed for 5 years at 5% interest. This would result in a car payment of $472 per month. At the end of the 5 years or 60 months the buyer would have paid $33,420 for a $30,000 car. The interest paid over the life of the loan was $3,420. That is an additional 10% plus added to the price of the car. Let’s look at the results after 5 years.
Car’s value after 5 years: $12,000 (5 year old car has typically lost 60% of its value)
Car Purchased with Cash:
Let’s look at an alternative to the let’s go in debt to buy a car strategy. This time a car is bought for cash, $5,000, and $472 per month is saved. For this scenario the money saved will go into a 401K earning 8% for the same 5 years or 60 months. At the end of this time the buyer of the cash car would have $34,817 toward his or her retirement, $6,497 from interest earned. This doesn’t include any likely employer match, so is a conservative number. Let’s look at the results.
Car’s value after 5 years: $3,000 (there is much less depreciation for an older car)
Retirement savings Value: $34,817
Total Value: $37,817
Which of these two scenarios would you rather have?
Millions everyday answer this question by buying a car on credit and going into debt. They are trading their future securtiy to drive a better car today.
Some readers at this point might be ready to point out I haven’t included vehicle maintenance and that maintenance can be a big factor when buying a used car. This is a true, but my response is one can do a lot of repairs for $34,000.
It is now time for a question to you. Whose bucket are you filling? If you answered someone else’s, come back and let me help you start to fill your own.
In next week’s post I will start the process of providing tips on how a good cash car can be bought for $5000 or less.
Question: Besides buying a cash car and saving for retirement, what else could you do to fill your own bucket?