Cars = #1 Wealth Killer
In this post we are going to talk about the #1 wealth killer in America - our cars.
You might be thinking. Tae, what are you talking about? Aren’t there so many other things that should come before a car payment that is destroying our wealth? How about the rising costs of healthcare? Or stagnating wages? And what about the crazy inflation rate that is destroying our purchasing power?
Yes. All true. And I don’t disagree that many of these impact our wealth in detrimental ways. However, if you hear me out for the rest of this post, I want to help you understand why I believe our cars are really the #1 wealth killer here in the United States.
America's Obsession With Cars
First let’s start out with some history lessons so we have context regarding cars and America. Let’s face it. We as Americans are obsessed with cars, and nothing says American as our cars. These days it’s hard to see distinction between car culture and American culture as cars have been such a significant part of our lives since they first came to be.
Ford Model T - It All Started Here
A big part of why they’ve stuck around is that they are the epitome of status. This allure of status that keeps drivers hooked dates all the way back to the Ford Model T. The first affordable American car that changed America as we know it over a hundred years ago. Since then cars have continued to represent itself as an extension of ourselves and therefore our identity, our status symbol and a way to show the world how successful we are.
When someone parks their Lamborghini right next to our 10 year old Honda Civic, don’t many of us think. Man what does this guy do for a living? How is he so wealthy? He is so cool.
In my mid twenties I made one of the biggest purchases of my life - a brand new Volvo S-40. I had just gotten my recent promotion in the Army and was making decent money. Of course I was still living paycheck to paycheck. I justified the purchase by saying that I deserved it and I worked hard for it. And while that might be true, the truth is that I could have bought a much cheaper car and used that extra money to pay down debt or invest in my future. But I didn’t.I wanted the status symbol. I wanted the car that would turn heads when I drove by.
Now a Volvo isn’t really associated with turning heads, but at the time, I sure felt I was somebody. And that is really the core problem with cars. They are most often emotional purchases. We buy them with our heart and not our head. And when we do that, we often end up overpaying and making poor financial decisions just like I did.
Cost of Owning a Car
Alright, now that you had a good laugh at my money mistake, let’s actually look at some numbers and see how cars are literally killing our wealth. Let’s try to understand the average cost of owning a car. At the time of this post, the average price of a new car in the US is around $48,000. And given most new cars are purchased financed, the average monthly car payment hovers around $700.
When we consider on-going costs like insurance, gas, or maintenance. When we factor all of that in, the true cost of ownership is much higher. And we aren’t even factoring in depreciation when purchasing a brand new car. A new car can lose up to 20% of its value the moment you drive it off the lot! And it doesn’t stop there.
On average, a car will lose about 11% of its value every year for the first five years. So if you bought that $48,000 car, in just five years it will be worth less than half of what you paid for it, and after ten years, it will be worth less than a third. So it's not a surprise that so many people are upside down on their car loans.
Car Payments Are A Bad Idea
The bottom line is that car payments in general are a bad idea. Especially big car payments like $700 a month. There might be unique situations where a car payment might make some sense. You originally planned on buying a new car with cash, but chose financing instead because they were offering a 0% APR. However, these situations aren’t normal.
The vast majority of people aren’t using car payments to help out their cash flow situation. Imagine an average person who started their first job at the age of 25 and settled into a $700 car payment for their entire life. This person would trade his or her car over the years, but would always have that car payment. Each time the car is paid off, we would head straight to the dealership to pick up a new one.
If we did this for 30 years, we would have paid over $252,000 in car payments alone, and in the end, we would only have an older car worth almost nothing to show for it. Worse, as I mentioned earlier, this figure doesn’t include the extra money we pay for maintenance, insurance and other associated costs with owning a car.
Less Car Payment = Increased Wealth
Now imagine that we did something radical and decided to forgo or reduce this hefty new car payment for our entire life. We decided to purchase a smaller new car. A reliable used model. Or even more radical, use alternate means of transportation and rented cars only when we need one. In this scenario, let's reduce our monthly car expense by half the national average car payment. Instead of spending $700 per month, we instead spend $350 per month, and we invest the extra $350 in a good low cost index fund for 30 years.
How much do you think we will have in our investments after 30 years? At an average of 8% rate of return, over $521,625 dollars. The total contribution amount is $126,000, but compounding added close to additional $395,625 to our investments. For half a million dollars, I personally don’t mind driving a humble economical vehicle versus a car that supposedly shows my wealth to the rest of the world that really doesn’t care about me.
Car Payments Are Not a Way of Life
Car payments are not a way of life, and if we think that since we had one ever since we can remember, it's time to change that mindset. It’s easy to blame external factors for our life and money problems. But what is interesting is that most often, we blame everything but our high car payments for our inability to get ahead.
We blame our employers for not giving us the raises we deserve, or our parents for not educating us enough. We blame health insurance premiums, the price of groceries, the housing market, and even the price of gas. But, how often do we focus our efforts on our high car payment? Most often not.
We’ve become socially conditioned to believe a huge car payment is a fact of life because having a nice car is a way of life. It’s an extension of who we are. We wouldn’t go out to the mall wearing tattered clothes, so how can we be on the road with a run down vehicle? We tell ourselves that everyone has a car payment, and that it’s normal and okay, and if we’re going to have a car payment anyways, we might as well get the car we want, right?
This kind of thinking is so widespread and so embedded into our culture, it’s practically an epidemic. The fact is that we don’t need to think this way, and in actuality, it is very harmful to think this way because it’s detrimental to our wealth.
Positive Car Habits
Alright, so now that we recognize the detrimental impact of having a car payment is to our wealth, what can we do? Let me share with you some practical tips.
Delayed Gratification
Number one tip is a bit general, but it is to delay gratification. Or learning delayed gratification if this is something we struggle with. I totally empathize with people who like buying new cars. If we are completely honest with ourselves, myself included, buying a new car is fun. Not only do you get to enjoy that coveted “new car smell,” but you get to show off in front of your family and friends. And no matter how much the privilege costs, it feels so good to drive your new car off the lot and cruise down the street.
Unfortunately, that's short-term thinking as many of us might have experience first hand. The new car smell? The excitement you feel when you get to drive your new car to work? I’m sorry to say but those feelings are temporary; they’re fleeting. After a fairly short amount of time, the new car excitement turns into a mundane, uneventful reality. Once your car isn’t new anymore, it’s just something you drive to Costco on a weekly basis.
If you want to do something different and build your wealth in the process, you have to change your new car mindset. Learn to delay gratification. If you currently have a car and have been thinking about getting a new one, see if you can drag it out for several more years. This simple act of delayed gratification can mean hundreds of thousands of dollars in the long run.
Consider Used Cars
Second tip is a bit more practical, and that is to consider buying used. As I mentioned earlier, one of the greatest negative financial impacts to buying a new car is its depreciation. A new car can literally lose up to 20% of its value the moment you drive it off the parking lot. After 5 years, it will be worth no more than half its original value.
A used vehicle depreciates at a much slower rate than a new vehicle. This is because once you are behind the wheel of the vehicle it will have already undergone its major depreciation. It's much cheaper thus your monthly payment will be lower if you decide to finance. If you are worried about the condition of a used vehicle because you never purchased one, consider a certified pre-owned model. You will still save money by buying a used car but gain additional confidence in the reliability of the vehicle. In essence, Certified pre-owned — or CPO, are vehicles that meet a manufacturer’s established standards and carry some form of guarantee against defects, similar to a new-car warranty.
Never Lease
The third tip is to never lease a car. Leasing a car is tempting because the monthly payments are significantly lower than purchasing a car. However it gets quite expensive in the long run. When you lease, you're basically paying for the use of the vehicle for the first 2 or 3 years of its life - when the car depreciates the most.
When your lease is over, you either have to lease another car or purchase one - starting the cycle all over again. Buying a new vehicle might be expensive initially, but once you paid off the loans, you at least own the car and won’t have any car payments as long as you continue to drive it. With leasing, you don’t have that option. You will always have a car payment.
Consider No Car
The fourth tip may sound extreme, but consider no car. If you live in an area where there is good public transportation and you don’t have to commute long distances for work, it may be feasible to ditch your car altogether. Not only will you save on car payments, but you’ll also save on gas, insurance, and maintenance costs. It may not be the most glamorous solution, but it is a very practical one that can free up a significant amount of money each month.
Cars are one of the biggest wealth killers out there. If you want to build true wealth, you need to be mindful of your car choices and avoid the temptation to overspend. There is nothing wrong with owning a car – but there is something wrong with letting your car own you. Think carefully about your needs and make smart financial choices that will help you grow your wealth over time.
