If you are thinking of purchasing a car, there are several costs that you take into consideration whether you realize it or not. If you are anything like me, you try to get a dependable car that will have few maintenance issues while also not being really expensive. In fact, the price of the car and the anticipated repair costs seem to be the two most common factors when purchasing a car. Granted, many people are now also considering the miles per gallon of a vehicle as well because of the high fuel costs.
Besides these obvious costs of a car, is there anything else? If you have purchased a vehicle without considering the most often overlooked cost of owning a car, you may not be making the right choice when it comes to selecting the most bang for your buck. In my mind, the expense that is often excluded from any calculations is depreciation.
Why Depreciation Should Be Considered
You may be wondering why depreciation really matters all that much. If you are buying a car and by some miracle, it does not need any repairs, the only expense that you would have is the initial price of the car, right? Unfortunately, this just isn’t the case. No matter what you do, you will most likely end up selling your car at one point. The rate at which your car loses value affects the amount for which you will be able to sell your car later. Failing to calculate depreciation is like saying that you will never sell your car – which hardly ever happens.
Let me give you an example of why this is important. Imagine that I have a choice between two cars that I want to buy. For this illustration, I am going to exclude the costs of anticipated repairs. You should also do your best to consider the expected repair costs, but to illustrate the importance of depreciation, I have left out repair costs of this example for simplicity.
How to Calculate Depreciation
One car is $10,000 while another is $8,000. If both cars offer similar features, I would bet that you would want to buy the car for $8,000. A simple calculation tells you that you are saving $2,000. However, this popular calculation means that you are failing to consider the resale value. If the car for $8,000 depreciates at a higher rate than the other car, this also means that you will not get as much money for it when you sell it (depending on how long you keep the car).
Let’s imagine that we know that the $8,000 car depreciates at a rate of 15% each year while the $10,000 car only depreciates 10% each year. Which one would be the better buy?
The easiest way to calculate which would be the better buy is to consider how much it will cost you for the length of time that you will own it. If you were to keep the the first ($10,000) car that you purchased for 1 year and turn around and sell it, you could sell it for $9,000. This means it cost you $1,000 to own the car. The second car, at a 15% depreciation rate, means that you could
sell the car for $6800, equaling $1200 for the year, a difference of $200. If you
continue to evaluate (using these hypothetical figures) the total cost of the car,
it isn’t until the 10th year that the second car costs less.
See the chart below for a detailed comparison:
Car #1 Value
Car #2 Value
While this illustration is based on hypothetical figures, it does give you an idea
of how important of a role depreciation plays. By shifting your focus to long term (instead of just focusing on the asking price), it is possible that you could save yourself hundreds if not thousands of dollars. Saving money from the small things over the course of my life is one of the things that will allow me to retire early. So, the next time you go to purchase a new(er) car, make sure to take the time to consider the resale value.
Do you consider the resale value when you purchase a car?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.