Driving home with $1 million

PORTFOLIO POINT: Over a lifetime of driving, it’s possible to save over $1 million just by buying second-hand cars instead of new ones.

One of the surprisingly important financial decisions you might have to make revolves around buying a car. 

This is because a car is the biggest purchase that you make that actually falls in value. We all know that the day that we drive a car off the showroom floor it falls in value by thousands of dollars – but what is less evident is the financial impact of slightly changing your purchasing habits.

Let us consider the Holden Commodore as an example of a family car. According to redbook.com, a 2009 model (i.e. three years old) is given an average private sale price of $16,550. It sold for $33,990 when new.

This is a graphic example of how quickly cars ‘depreciate’ in value – this Commodore (which is still the current VE model) has fallen in value by more than half. 

This car has fallen in value by $17,440, or $111 a week. Think about this as a proportion of the average wage (about $1300 a week) – it is nearly 9%. And that is before rego, petrol, insurance and servicing.

What then becomes interesting is that the average private price for the basic six-year-old Commodore is $9,350. Between years three and six it has fallen in value by $7,200, or only $46 a week.

Here is an interesting thought. Let’s say you had two cars in your garage. One was a 0 – three-year-old Commodore, the other a three – six-year-old Commodore. Each week you had to choose to rent one car. The cost of the rental was equal to the weekly depreciation. If you wanted the newer car you had to pull $111 out of your wallet. The older car only costs $46. Which would you choose? 

The next interesting calculation is to consider the impact of driving a three – six-year-old car over a driving lifetime (say from age 20 to age 75). What might be the impact of the difference in depreciation over that entire time choosing to drive the slightly older car?

However, before doing that I want to add some extra expenses to the older car. It is reasonable to think that it might require more servicing, be sold with older tyres etc. So, let’s assume that the extra costs of the older car are $15 a week. (remember that it is only a three – six-year-old car, it is not a 10-plus year-old car that might need significantly more spent on it).

The difference between the two cars is $50 a week. The new car ‘costs’ $111 in depreciation. The older car costs $46 in depreciation, plus an extra $15 in extra costs for a total of $61.

Firstly, as a straight sum – $50 a week, over a 45-year driving career, comes to a total of $117,000. If we assume that car costs rise with inflation, and the way they depreciate remains similar, that is $117,000 in today’s dollars. Not an insignificant sum of money.

However, that calculation assumes that the money is just stuck under a mattress. Let us invest that money, and assume a return after inflation of 6% a year. It is important that it is an after inflation return, because that means the figures stay in today’s dollars – giving us an idea of the purchasing power of this money today. Six per cent after inflation is a reasonable return over a 45-year period if we consider an investment in growth assets like property or shares.

The amount accumulated by investing the difference between a 0 – three-year-old car and a three – six-year-old car grows to a very impressive $552,000. For a couple that both have a car, that totals $1,104,000 in today’s money.

Now, putting together a spreadsheet with calculations means that the variables can be quietly manipulated to give you the answer you need. Which begs the big question, how much would we have to earn on a saving of $50 a week to have a final balance of $1,000,000 in today’s money? 

The answer is 7.96% a year after inflation. This sort of return is actually possible – although toward the higher end of what might be expected from shares or property over longer periods of time. That said – it does show that the way you choose to purchase your car may actually be a $1 million decision!

The book ‘The Millionaire Next Door’ by Stanley and Danko, looks at the spending habits of millionaires. They find that many millionaires buy second-hand cars and relatively low-cost, basic locally made cars (it is a USA book). The suggestion – actual millionaires don’t spend large amounts of money on cars that will fall substantially in value.

Conclusion

This is a calculation that should be viewed as somewhat rough. It is hard to find actual figures for possible extra figures for the costs of the older car, it assumes that people sell their car every three years, and it assumes that cars continue to depreciate in the same pattern, and increase in value in line with inflation. (Who even knows what we might be travelling in 45 years down the track!). 

It is interesting, however, to think about the rate at which a new car falls sharply in value. Buying the same car, as a three-year-old vehicle, might be a financial decision well worth weighing up.

Scott Francis is an independent financial adviser based in Brisbane.