Cars and radiation …

What do cars and radioactive material have in common?

Well, besides each being a potential environmental disaster if not managed well … they both have a half-life:

- For radioactive material, it’s the period of time for a substance undergoing decay to decrease by half,

- For your car, it’s the time it takes for you to lose half your money!

This is because the largest cost of auto ownership is not the finance charges, the taxes, the gas that you put in the tank, or even the tires or repair costs … it’s a largely ‘hidden’ cost called depreciation.

You see ‘depreciation’ when you sell the car as The Amount You Paid less The Amount That You Get Back.

Even the amount that you get back helps to hide the true depreciation cost because you will often trade in the vehicle and the dealer might ‘sweeten’ his offer by giving you a higher trade-in figure than the car is really worth … but, what he is really doing is giving you a discount on the purchase price of the new car (a discount that you may well have received – or exceeded – even if you didn’t offer a trade-in).

Even if the 15% to 20% p.a. depreciation claimed by Debt Free Bible is true, what effect does that have on the value of the vehicle?

The chart shows if you paid $25k for your new car, you can only get $12,800 if you sell it after 3 years, even if you decide to hang on to the car, it has cost you $25,000 – $12,800  = $12,200 …

… or, $4,067 a year!

[ AJC: And, don't forget all of those other costs that we mentioned: "the finance charges, the taxes, the gas that you put in the tank, or even the tires or repair costs" ]

So, how accurate is that “15% to 20% p.a. depreciation claimed by Debt Free Bible”?

Well, a paper published by the IAES, which evaluated the depreciation rate of 15 automobile brands available in the USA for the years 2000-2004, yielded 5 tiers of depreciation rates:

Tier One: Honda and Lexus with an average annual depreciation rate of 13.4-14.1%.

Tier Two: Volkswagen and Toyota with an average annual depreciation rate of 16.5-16.8%.

Tier Three: Nissan, Mercedes, BMW, Hyundai, and Mercury with an average depreciation rate of 18.9-21.2%.

Tier Four: Chevrolet, Chrysler, and Saturn with average annual depreciation rates of 25.4-27.5%.

Tier Five: Dodge, Ford, and Buick with an average annual depreciation rate of 31.1-32.6%.

Now, using these rates, I have calculated the Half-Life of each brand for you, simply by using the Rule of 72 [AJC: divide the depreciation rate into 72; the answer is the number of years it will take to halve the purchase price] ….

Use this table to find 7 Million 7 Years Patented Half-Life For Your Next Car:

Honda / Lexus: 5 Years 3 Months.

Volkswagen / Toyota: 4 Years 4 months

Nissan / Mercedes / BMW / Hyundai / Mercury: 3 years 7 Months.

Chevrolet / Chrysler / Saturn: 2 Years 9 Months.

Dodge / Ford / Buick: 2 Years 3 Months.

Using this information, you could do some very fancy tables about the break-even point of spending more to buy a new (say) Lexus instead of a new (say) Nissan – factoring all the other costs of ownership, if you want to get real fancy – given that you have a couple of years worth of depreciation to play with …

… rather, I would like you to see that you are far better off buying a second-hand vehicle of the type that you are after, so that you can pay half-price

You do this, simply by buying a 4 year, 4 month old Volkswagen, or a 3 year, 3 month old Buick, etc.

Get it?

And, even if you were determined to buy new, you are still probably better off buying a slightly ‘better’ brand used – even if it means going up a tier or two – than you are in buying a new ‘standard’ brand auto.

Sorry GM and Ford, but you are in DEEP trouble, because you simply aren’t competitive!

Never borrow to buy a new car …

You think you need to dig yourself further into debt to get that new car? Think again …

… there’s always another way [Hint: even if a Higher Power doesn't simply drop one into your lap, you could try saving up for one ]

Can you eat a car?

I’m rapidly becoming the ‘Dear Amy’ of personal finance blogs (don’t let this stop you, I actually love receiving these types of e-mails!); Tam asks:

I am working to pay off my expensive debt which should be paid off in the next six to eight months. However, my dilemma is I LOVE cars. I want to finance (w/ a sizable down payment) a new car after my debt is paid off. I’m trying to talk myself out of it because I know I should be putting that money toward my financial goals but I just keep saying that if I can get this car, then I won’t want anything else and will be satisfied. Deep down, I know this is not true because three years later, they’ll be another new car that I will want. What can I do to stop myself from buying this new car (Nissan 370Z Roadster)?

 Man, what can I say?!

I could point Tam to the post that said not to buy a new car, or to the one that said not to finance, or even to the one that said not to spend more than 5% of your net worth on ‘stuff’ (including your car). 

I’m guessing that any one of these would be reason enough not to buy the car … instead, I just offered Tam the following advice:

Don’t!

Can you eat a car?

The Power of 10-10-10

Suzy Welch, in her new book of the same name, calls 10-10-10 “a life-transforming idea” …

… I don’t know about ‘life-transforming’ but, it’s definitely a simple-yet-powerful decision-making process.

Suzy says:

I call it 10-10-10.

Here’s how it works. Every time I find myself in a situation where there appears to be no solution that will make everyone happy, I ask myself three questions:

What are the consequences of my decision in 10 minutes?

In 10 months?

And in 10 years?

The answers usually tell me what I need to know not only to make the most reasoned move but to explain my choice to the family members, friends, or coworkers who will feel its impact.

I can definitely see how these questions could apply to personal finance: before you make your next major financial decision, take some time out to ask yourself how that decision to [insert financial decision of choice: buy, sell, finance, change, etc.] could affect your life in 10 minutes / 10 months / 10 years.

Chances are that you will change your mind

Tomorrow, I’ll show you an even more powerful idea that will go hand-in-hand with 10-10-10 to “totally transform” your personal spending habits …

Cash Cascade your car?

I often get comments from new readers asking where to start: so, I start from the premise that living frugally and working for 20 to 40 more years to retire on the equivalent of $15,000 today isn’t what you had in mind? If it is, then this blog isn’t for you

OK, so you’re still reading … great! In that case, the place to start is to work out what you want from your life and how much it will cost you to get it; here is a site that shows you how to work all of that out: http://www.shareyournumber.com/ Visit it (and, join the Community) … not only is this site totally free, I promise that it will be truly Life Changing.

Once you confirm that you do need to make $7 million in 7 years or $3 million in 10 years (or anywhere in between) then you’ll probably want some ‘quick start tips’; well, let’s start with your greatest expense: your house. This post – if you follow all the backlinks – will tell you all you need to know to make sure that your house actually HELPS you get rich(er) quick(er) instead of poorer: http://7million7years.com/2009/01/12/how-much-house-can-you-afford/.

And, if you’re struggling with questions around debt, then this post will totally change the way that you think about ‘good debt and bad debt’: http://7million7years.com/2009/03/25/debt-snowball-debt-shmowball-as-long-as-youre-rich/.

If you’re still with us after that, then sign up for e-mail updates and trawl through the site to see what you can find, just like this guy did …

_______________________

I’m glad that some people still rummage through my older posts, as the principles of money don’t age (reference the Richest Man In Babylon, for example) …

… so, I was pleased to have this opportunity to renew this discussion when John commented on this post about cars:

I know it has been over a year since you published this but I was wondering if you could comment on a few calculations I did after reading this post. My disagreement is mostly with the Finance Vs Cash option. The buying a used car part I totally get.

Let’s say I wanted to buy a car with an MSRP of 30,000. If I put 10% money down and get a loan of 27000 for 5 years at let’s say 5% APR. At the end of 5 years I will end up paying 33,571 for the car. If I had paid in cash I would have paid 30,000 for he car. The depreciation on the car would be the same in both cases. So I ended up paying 3,571 more for the car by choosing to finance it instead of paying cash.

But here’s the thing, by financing the car, I also ended up with 27,000 of cash which I can invest elsewhere. To recover the extra 3,571 that I’ll have to pay on interest for the loan, all I need to do is to put this 27,000 in an investment that can give me an APY of 2.52% only, which is not very difficult to find at all.

This suggests that buying with cash, even for a depreciating asset, does not make all that sense. Am I missing something here?

John is basically putting forward the idea of applying Cash Cascade principles to your car … and, given the parameters that he has set, John is absolutely right: it would be better to finance your car and invest the cash elsewhere …

… at least, in principle.

However, in practice, I’m not so sure that the Cash Cascade actually would suggest that you DO finance the car.

Here’s why:

Reason # 1 : It’s unlikely that you will see 5% APR on a auto loan

5% APR car loans are not unheard of, but they are relatively rare; MSN Money cites the current national averages for auto loans as:

So, while auto loans as low as roughly 4% (an internet only ‘special’) are available, most are in the 6% – 10% range; and, don’t forget to factor in any added fees!

Of course, you MAY be able to take a 5% HELOC on your house to raise the cash for the car, but I wouldn’t recommend a short-term loan (i.e. a HELOC) for a long-term use (i.e. financing your car over 2 to 5 years) because the bank can change the terms – or even cancel your HELOC – whenever they feel like it. Then you might be stuck with getting a more conventional loan at a higher rate (there goes your 5% loan!).

On the other hand, a refi may do the trick … but, you need to watch both the 25% Income Rule and the closing/refi costs, which are likely to push you well over the 5% if amortized over the expected life of the car loan (you’d be crazy not to have a 2 to 5 year loan payback expectation).

Reason # 2 : It’s likely that you can beat a 5% APR auto loan

This seems to contradict Reason # 1, but doesn’t …

… you see, if you do find a 5% APR loan, it will most likely be offered by an auto dealer. However, the chances are that it comes with a catch: the car isn’t discounted as much as it could be!

A low (or even zero) APR loan is a very common manufacturer / importer / dealer incentive … but, they do a deal with their finance company (often manufacturer-owned, like GMAC) whereby they pay the differential interest rate for you and up front. Back to the catch: they load the price of the car to offset the pre-paid interest component. Sneaky, huh?

Reason # 3 : Even if you can’t beat the 5% APR auto loan you’d better have the cash ready

But, let’s assume that you go to the Pentagon Federal Credit Union for the only 4% APR rate that I could find that wasn’t loaded with fees, and they do give you the loan …

… you had better have the cash ready to buy an investment reasonably quickly.

If you don’t have already have the cash saved up then you should be prepared to save up until you have the lump-sum cash then decide if you want the car only or both the car and the investment. No point borrowing money for the car and trying to save up for an investment … unless, you really, really, really need the car right now!

… oh, and if you’ve read all the way to here, then you might want see what my 7 Millionaires … In Training! are up to; kind of like American Idol Meets The Apprentice …except it’s online

The upside down car?

Trees Full of Money shows us how to deal with a situation where we’re ‘upside down’ on our car loan:

If you can no longer afford your “upside down” vehicle, here is a a better way to get out of your loan:

Step 1
The most important step in unloading a vehicle with negative equity is to accept the situation for what it is. Saying “if I sell my vehicle now I’ll lose money” is not a plan. The quicker you sell your “upside down” vehicle, the less money you loose due to further depreciation.

Step 2
The second step in selling an “upside down vehicle” is deciding on a fair market value. Lately, the value of used vehicles has been just as volatile as the stock market or the price of oil. The fair market value of your vehicle may be significantly more or less than used vehicle pricing guides such as NADA and Kelly Blue Book suggest.

Step 3

Once you’ve established a competitive price, you need to secure funding for the difference between what you owe and what the vehicle will bring.

Step 4
Once you have met the obligations of your loan, it’s time to do a little marketing and salesmanship. I little effort in the marketing of your vehicle can pay huge dividends.

Step 5
When you have identified a prospective buyer for your vehicle, be sure to ask your bank how to proceed with the transaction. Each state has different laws so be sure to contact your state’s motor vehicle division as well.

[AJC: If you do want to sell your financed vehicle, I recommend that you read the full post here, as I have only extracted TFoM's highlights]

But, where is Step 6??!!

It should be the one that says: how do I buy a replacement vehicle?

You see, unlike many things that you may choose to own, a car is probably a necessity … now, that doesn’t mean that you need the best car, but you do need a car that can achieve [Insert objective of choice: get to/from work; haul stuff around the farm; schlepp the kids; etc; etc].

So, what do you do?

Well, you first try as hard as you can NOT to get yourself into a financed vehicle in the first place …

… you see, almost anybody who has a financed vehicle is in a negative equity situation:

- As soon as you walk a new car off the lot it has depreciated 10% to 30%, yet you still owe 100% – deposit + payout costs on the loan,

- If your loan is longer than a year or two, the car is probably depreciating at a faster rate than you can pay down the loan.

If you’re not convinced that you are already ‘upside down’ on your loan, ask for a ‘payout figure’ from your finance company – this is the amount that they would expect in a check today to hand over the title to the vehicle to you ‘free and clear’ – and, get ready to choke! Go on, try it …

So, don’t get yourself into this predicament!

But, if that is the only way that you can get into your first set of wheels (is it really, truly the only way? Or, are you just kidding yourself?!), or you are already into a financed vehicle, don’t sweat it.

Just take a look at your current monthly payments and the payout cost … if you can payout the vehicle and buy a cheaper one with cash, go for it. But, the chances are you will need to hang onto your current vehicle, as long as you can afford the payments.

Now, if you can’t afford the payments and you ARE upside down on the loan (as you surely will be), you will need some help to negotiate your way into handing back the vehicle, walking away from the loan and finding a way to start again. Now, that’s a whole can of worms that you just don’t want to open …

… so, next time you’re thinking of upgrading your car with a nice little “low-interest dealer loan” … don’t

Car or curse? 7 case studies …

We all have a car … otherwise, we’d be cycling to work. But how much car? Do you buy new/old or somewhere in-between? After all, our car is one of our largest purchases … if not, largest purchase outside of our own home.

So, here’s 7 case studies from our 7 Millionaires … In Training! ‘grand experiment’.

Let me know what you think …

Scott – like so many of the 7MITs featured here – loves his BMW’s … in fact, even AJC happens to have one, at the moment! The best thing, for Scott, is that his employer provided his current BMW for ‘free’ … but, is there really such a thing as a ‘free lunch’? We explore that very issue …

Ryan also likes BMW’s, which cause Josh to recommend buying a new one because it means NO “maintenance bill for 4 years, 50,000 miles” … is this a good deal?

Josh is obviously the other BMW-fan; we use his post to re-introduce the 5% Rule for cars and other possessions; should Josh have broken the rule to get int his first car? You might be surprised by the answer (it’s in the comments)!

Lee sure knows how to run a truck into the ground! Take a look at his attitude towards financing vehicles and how long you should hold on to your truck for …

Mark – the savvy investor – shows the other BMW-lovers how to buy a good used one off e-Bay and negotiate the price lower AFTER you have already ‘bought it’ … nice!

Diane and I have a discussion around what comes first, the “debt or the car”? It’s moot … Diane know what she needs to do!

Jeff has the cars the boat and the airplane (well, the airplane is supplied by the Navy!) … but, at what point is it better chartering a boat than owning one?!

… oh, and I finally come clean on my own car-related successes and failures, here

Let me know about yours!?

No such thing as a free lunch …

This concept has come up three times recently, so it deserves a post of its own!

First Time

My son asked me why he can’t buy a car (when he’s old enough) on finance, and I explained it to him…

… he then asked me the million dollar question:

What about if there is a 0% finance deal on the car? Can I finance it then?

And, my answer was:

There’s no such thing as a free lunch.

Second Time

Ryan was posting about his car and Josh commented:

I would suggest buying used until you have cash to buy a new…BMW, you have no maintenance bill for 4 years, 50,000 miles.

And, my answer was:

There’s no such thing as a free lunch.

Third Time

I wrote a post about a hypothetical real-estate deal, with the key feature of a rental return guarantee. Rick said:

The description sounds like a good deal to me for a low risk- a guaranteed 7.5% return + possibility of great appreciation. It really sounds too good to be true.

And, it is (too good to be true); you see:

There’s no such thing as a free lunch.

… really, there isn’t. Somewhere along the line you are paying.

Let’s take the last case first: guarantees are usually not worth the paper they’re written on. Especially when they are “thrown in” to make a “great deal” sound even better. In the real-estate deal the ‘guarantee’ could actually cost you money, if the developers/promoters have to borrow money against the future value of the project to make a current payment to you.

In most  new projects where, say, a 2 year rental guarantee is offered, the value of the guarantee is built into the price that the property is offered to you at … might explain some of the very dramatic rises and falls in RE values in Florida, for example.

Similarly with the second example of the ‘free servicing’, which is – of course – built into the price of the car. Naturally, if you simply MUST have a brand-new BMW then you will get the ‘free’ servicing with it. On the other hand, if you can buy a used BMW just after the ‘free servicing warranty period’ has expired, you will be buying at the best possible price point, because (in a normal market) you should expect a sudden drop in the value of the car … this sudden drop represents the real, current value of the ‘free servicing’.

If you understand this concept, then so-called 0% down deals should become obvious … YOU are actually paying for all of the interest, at commercial rates, up front!

I did some consulting work for a finance company that underwrote so-called “2 year interest free” loans on furniture sales for large retailers; they made their money because the store paid a fixed amount up front when you signed up to the deal, then the finance company HOPED that you would not be able to make all your payments on time, because the ‘fine print’ on the deal then let them charge you interest at credit card rates (19% p.a. to 29% p.a.) on the entire financed amount for the entire time that you had the “0% loan”.

Here’s the test; always ask:

… and, if I don’t take the [insert: free lunch du jour] how much do I have to pay then??

Then you can decide if the free lunch is something that you can afford!

A free car?!

Clever video by the Dave Ramsey ‘marketing machine’ … really shows you the anti-power of financing a car. Watch it and you may never finance another car again!

The greatest advice from the Oracle of Omaha

As the latest in my ‘videos on sundays’ series, I offer some advice from the man billed as the ‘greatest investor who ever lived’.

 In 7 minutes you will have ALL of Warren Buffet’s secrets

… maybe not, but you WILL have some insights into his life (the first three minutes) followed by some of the best investing advice that I have seen.

Warning: some of these slides flash across your screen so fast that you will have trouble following them, so pay attention to the very last two slides if you are not an expert investor:

http://youtube.com/watch?v=iW1eg9p5wq4

BUT …

If you are a student of investing, have a long-term view and are willing to dedicate some time and effort, take note that Warren offers exactly the opposite advice for you …

Wide diversification is only required when investors do not understand what they are doing.
Warren Buffett

… he also points to this time in history as being possibly a great time to make your fortune:

We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
Warren Buffett

I see a lot of doom and gloom … I bet that Warren Buffet is gearing up for something big …

What are you doing right now?