Spend All Your Money on Rapidly Depreciating Metal!

Pickup trucks for the weekend warrior! They sure are popular. As I drive around I see more and more expensive, fancy ones driving around here in the plain vanilla suburbs. It makes laugh and also wonder how everyone suddenly has enough money for a $70,000 vehicle yet they don’t have a dime for emergencies if they lose their job or need to pay for a surgery. If you would have told me five years ago everyone would be driving around in a brand new Mercedes Benz E class or BMW X5 I would have laughed and said most people are not that rich! But that is the situation we find ourselves in. These things cost even more than the X5 and Benz E class. Hmmm seems suspect.

Are they a good investment?

Probably not unless you happen to need it to do your job in farming, construction, lawn maintenance, logging, ranching or as a park ranger looking after Yogi Bear. Even for those guys the same financial logic applies and they need to thrifty. That means no top of the line luxo barge with heated leather seats and panoramic sunroof. This is a work tool after all that is going to get dirty and make you money!

So why am I not a big fan of these vehicles?  Opportunity cost and rapid depreciation!

Opportunity cost? What’s that? That is saying what else could you do with the same money. I mean $70,000 is a lot of money. Let me give you an example. If I give you $70,000 USD to spend what do you do with it?

  1. You can buy a fancy SUV, car or pickup truck now. Cost $70K. You enjoy now. Forget about tomorrow.
  2. You invest that money in the stock market in say a growth stock and drive a $10K beater car instead like a used Honda CRV or RAV4. That gives you $60K to invest.

Let’s see what happens five years down the road.

Option 1: The truck/SUV/car depreciates rapidly. At the end of five years your vehicle is now worth $30,000. So you are -$40,000 in the hole! Doh!

Plus you have paid interest assuming you financed the vehicle. Average car loan rate 5%. So over five years that makes a car payment of $1320.99/month. Over five years $79,259 for total interest paid of $9259 USD.

Adding together your interest plus the depreciation you have lost $49,259 of your investment! You are a Money Fool! Put on that dunce cap and go sit in the corner!

Option 2: You buy Google stock with $60K and drive the $10K car to work. Looking at the prices chart below.

At $750/share you buy 80 shares of Googl. After five years the share price is $1778/ share and those shares are worth $142,160 USD. You gained $82,160 in five years. You more than doubled your money. There is no dividend on Google stock so we don’t need to account for that. However your beater car is now worth $5000 only so you have lost $5000 in depreciation. Still you are up $77,160 USD. Nice going!

The difference between those two scenarios is $126,419! That is some real money. That is not including additonal costs for

Higher insurance: Let’s say $1000 per year so $5000 over five years

Higher fuel consumption: Let’s say you drive 20,000 miles per year. One gets 25 mpg and the other gets 10 mpg on average. 15 mpg difference is 1200 gallons at $4 gallon = $4800 per year. Over 5 years $24,000 in extra fuel.

Total cost difference

  • Vehicle versus stock: $126, 419
  • Insurance: $5000
  • Extra fuel: $24,0000
  • Total cost difference $155,419

So the moral is before you spend a lot of money on an asset that depreciates rapidly think about what else you could do with the money. How about spending it on an asset that appreciates in value? You can use those gains to put 20% down payment on a house or apartment. Those mostly appreciate in value at least at the rate of inflation. You could also buy a rental property, stocks, save for retirement etc.

The thing to keep in mind is that money can now be reinvested again and again, meaning snowballed into real money. Before you know it that $77K can go from $77K to $144K to $288K and on and on. Warren Buffett didn’t start with billions after all. However there is no guarantee you will get these returns all the time. Some years will be good and some will be mediocre. The one thing that is absolutely guaranteed is that vehicle is going to depreciate like a rock!

But I paid for the vehicle with rising home equity so it was free!

The vehicle wasn’t free. If you let that money sit in the house you would have paid off more of the loan meaning had you sold it. The mortgage stayed the same but the house value went up. That means you owed less money on the house. It is as if you made more payments.

You buy a $500K house with 20% down so the mortgage is $400K. Now the home value increases to $600K. You are up $100K. Nice. You now only owe $300K if you were to sell the house instead of $400K. So you would get back $200,000 upon sale instead of $100K. That only holds true if you sell and all the houses around you probably also went up in value and now you cannot afford them without the gain in equity.

Keep in mind house values don’t just go up! They can also go down big as we saw in the financial crisis of 2012. So you could end up underwater meaning you owe more than the house is worth. Doh! Never take money out of your home equity to buy cars or anything that isn’t another house or rental property that makes money. Here you see why.

Now let’s say the housing market crashes. The house prices drops to $350,000. You owe $400,000 on the house. Your equity is now $100,000 minus the $50,000 drop in sale value so $50,000. However if you had taken out $50,000 to buy a car or truck your equity would be zero.

So the money is not free. It is your money you are spending. You are just counting on house prices rising. A house is merely a giant leveraged stock trading position. You are buying the house on margin. You need to keep the equity in so that you don’t get a margin call.

Why would you sell when you are underwater? Well you could get laid off and be forced to relocate to another city or state to find work. You won’t be able to afford to carry two houses for long. Or you get laid off and foreclosed on meaning it is a forced sale. Either having as much home equity as possible is key. Never listen to reverse mortgage or home equity sales pitches.

But I am going to finance or lease the vehicle!

Ok then. You still have to pay for it and now you are paying interest . Plus you are paying the heavy depreciation on the vehicle in the first three years of life. Let’s look at a simple payment example below to drive the point home.

Example 1: Pauly Pauper

Pauly is enamored with the Ford F-150 Raptor. He has seen them on the street and in the car magazines. He goes to his local dealer. While the vehicle starts at $53K they mostly have the limited variant which costs $67K. Pauly likes those leather seats so gets that one.

  • Cost of Ford Raptor 4*4 with tax and title $71K
  • Financing at 5% via Ford Credit
  • Term 8 years
  • Payment $899 per month over 8 years. Payment over five years $1339/ month

Pauly decides he really wants the truck. However he cannot afford the monthly payment over five years of $1339/month. So the dealer suggests he stretch the payments over 8 years to bring the payment down to $899/month. This is seems more manageable to Pauly.

Unfortunately due to this expensive truck Pauly also has insurance go up by $1200 per year. So his monthly payment is now $1439. Due this high monthly outflow Pauly cuts his 401K contribution from 15% to 5% and stops saving. This is a very poor decision and short sighted as he needs money to retire and to save for a new house down payment of 20%.

Pauly continues to live at his apartment complex while the landlord raises the rent by 5% per year. He has no equity and limited retirement savings. This is bad.

On top of that Pauly is paying a lot of interest on the vehicle. A whopping $15,304 in interest due to the long term of the loan of 8 years.

Total vehicle cost

  • Cost $67,000
  • Interest: $15,304
  • Higher insurance $1200 *8 = $9600
  • Total cost $91,904

Even worse Pauly is afraid to take the vehicle off road much for fear off damaging it. His friend Freddie Fourwheeler has no such qualms. He bought a used 2005 Nissan Xterra on Craigslist for $4000 cash and enjoys driving it off road in the country without care.

  • Again what else could he have done with that money if he was more frugal and invested the rest?
  • You don’t need to drive a terrible vehicle to save money. Even if you purchased one for $25K and invested the rest you would come out way ahead.
  • And if you want a truck buy a cheaper small one or a used one and save/invest the rest.
  • In today’s corporate world who knows when the axe will come so it’s nice to have some money around.
  • Also unless you have a lot saved for retirement you better get busy. Many developed countries plan to cut their pension and retirement plan payments in the future as they can no longer afford it. We know this will happen in USA. What that means is that seeing that price are going up and payments are going to go down is that YOU need to save more money. The best way to do that is to cut expenses. I love it when people say I will work until I am 65. Really? There are no 64 year olds in any company I have worked at and they most certainly are not working at the local construction site either.

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