If I showed up at my office in a brand new Porsche Cayenne SUV or Cayman sports car my coworkers would think I was nuts! They would be like wow he sure likes to take on a lot of debt and spend every penny he makes. Or maybe he is engaged in some sort of embezzlement of company funds or cheating on his expense reports. We better check him out. If I drove around the city people would assume either I am some rich tech guy on his way to his beach house or a really successful stock trader. You can buy a new Porsche Cayman sports car for $65K or a new Macan SUV for $60K and a Cayenne SUV for $75K. Big money for sure. Execs at my firm drive these and they make a lot of money.
Now I point this out as I see many people driving very expensive pickup trucks and jeeps like they were Hyundais and Kias. If you think I am kidding check this out.
- Ford F250 Lariat $73K
- Ford F150 Platinum $69K
- Jeep Wrangler Rubicon $65K
What in the actual F? This is akin to people driving around in those Porsche luxury and sports cars. Imagine regular guys driving Porsches and Range Rovers around like tech moguls or athletes. You would think they all won the lottery. If I drive around in a Porsche people will think I am nuts on my middle man income. However if I drive around in a top of the line pickup truck financed over 84 months it is ok as it is practical! But is it? Here is what I hear.
- I might need to pickup something up like a grill or sofa! Yeah how come the bed is always empty?
- There might be snow on the ground! How much does it snow where you are? An unweighted empty back end is going swing out into the nearest ditch.
- I might want to go camping! Ok you have so much gear with you it doesn’t fit in your car or SUV?
- I might want to tow a boat (even though I don’t have one). Great, more payments for things you cannot afford.
- I might go off road. Really? In a 75K vehicle? Most of these vehicles are far too long and wide for the trails. If you really wanna 4*4 buy a beat up Jeep, Xterra or 4 Runner and enjoy.
Ok great man. The difference is that an executive making $400K per year plus options can buy a Porsche like you and I would buy a new Kia or Hyundai. It doesn’t really dent their budget much at all. However for the $70,000 per year salary everyman spending $75K for a vehicle that they don’t really need is nuts. If you need to finance any vehicle over more than 60 months it is too expensive for you! 84 months? Really? You will be paying for it and paying for repairs. You will be underwater and pay a tremendous amount of interest in the process.
Which one is more prestigious? I guess it depends on where you live. Where I am a Porsche SUV will definitely turn more heads and interest more ladies than a pickup. Country club set luxury versus some construction guy. In other places maybe not so.
Either way neither vehicle is a good deal unless you have a really big salary. I am talking $300K plus. That is rare!
So why am I not a big fan of these expensive 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?
- You can buy a fancy SUV, car or pickup truck now. Cost $70K. You enjoy now. Forget about tomorrow.
- 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 $2050/ share and those shares are worth $164,000 USD. You gained $104,000 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 $99,000 USD. Nice going!
The difference between those two scenarios is $148,259! That is some real money. That is not including additional 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: $148,259
- Insurance: $5000
- Extra fuel: $24,0000
- Total cost difference $177,559
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 $999. 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 like the US, Canada, UK, Australia, Germany etc plan to cut their pension and retirement plan payments in the future as they can no longer afford it. 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. So be wise with the money and don’t squander it. Once you have that $300K per year job drive whatever you want.