Wednesday, February 14, 2007

Another Strike Against My Goal

As I get closer and closer to my first job, I've realized there a lot of expenses involved. Some of them are necessary, ie. suits, computer, etc. Others are just because I suddenly have more money that I've ever had before coming to me, ie. car.

Oh yea! But not just any car. Just like any 22 year-old, in the words of Ricky Bobby, "I wanna go fast."

I've got my eye on this beauty:
the new 2007 350Z.

MSRP with the options I want? $36,500. It's red cause its going to decrease the speed at which I reach my goal.

Now why I do tell you about it? Well for one, its a really cool car. But, more to the point of my blog, is to discuss the financial considerations that go into a car purchase.

When it comes down to it, cars are terrible investments. Few cars appreciate in value. But we have to have them. So what should go into the calculations in getting a car?

Things to Consider

  1. Sticker Price of the car - the most obvious expense is the upfront cost of the car
  2. Maintenance costs - regular oil changes, tune-ups, tire rotations, etc.
  3. Gas - its expensive now, and there's no real end in sight. This can really add up.
  4. Insurance - the faster, sportier, more luxurious it is, the more you'll pay
  5. Other expenses - such as taxes, parking fees, car wash, etc
  6. Resale value - the only real return. Most experts would say you lose 20% of the car's value just by driving it off the lot.
Once you add up 1-5, and then subtract 6, you'll find your real cost to own the car. But that's assuming you can pay for it all. If you need financing, you'll probably add at least another 5% to the total bill.

How Does Financing Work?
There are a few terms you should know before you get into any kind of financing:
  • Loan Term - how long you have to pay back the loan, usually listed as number of months
  • Interest rate - your annual rate to borrow is. This rate, divided by 12, is the interest rate you are charged every month.
  • Principal - the amount you actually borrowed
  • Down payment - how much you need to pay of for the car before the bank is willing to loan you the money
On loans in general, and car loans more specifically, a down payment is necessary to assure the bank that it can make some profit off the loan if you were to default, that is, be unable to pay off the loan.

A complex formula is used to determine your monthly payment. You can find a calculator here. Essentially, every month you are paying a portion of the principal as well as interest. Initially, you will be paying much more interest than principal. As you get closer to the end of the loan, more of your monthly payment will be devoted to principal.

A lot of people would suggest paying off loans as quickly as possible, to avoid the interest payments. However, I come from a school of thought that there is never a single right answer for all circumstances. Sometimes, a little debt is a good thing.

Are you unsure about when you should pay off debt? Feel free to leave a comment for me to address.


Rob said...

My friend, if your goal is truly to reach one million dollars by the time your thirty, I've got to say from what I've read so far, your doing everything wrong. Your timing the market instead of being a true investor. Going out and buying a sports car when you're so young. I wouldn't buy a car like that unless I had a net worth of at least 500K. You just don't understand how far that sets you back. The real cost of that car to you is probably about 100K.

Finance Guy said...

I would love an explanation of how the car purchase will cost me $100K, considering all servicing and repairs are paid by the dealer, except for tires.

My car cost $42K, of which I paid $12K, and I the interest cost will be an additional $3K. On top of this, if you consider insurance at $1400 a year and tires at $600 a year (way conservative estimates), that's an additional $8K for the next 4 years.

I plan to own the car for 4 years, so total cost of ownership is $42K + $3K + $8K, or $53K.

Add in gas costs (the additional from regular to super), I'd figure that's an extra $300 a year.

Total cost of ownership = $54,200.

Where exactly do you get a $100K figure from?

Anonymous said...

You only want to own the car for 4 years?

I agree with Rob, you are going to be hurt by this more than you realize.

What if you invested the $12000 deposit in the stock market with an average of 10% return for the 7-8 years before you are 30? The money would double or more! So, rather than take 12k and turn it into 24k you are taking 12k and turning it into -53k... a big difference.

Anonymous said...

that was a neg 53, but the "-" came out on another line. (just to clarify)

Finance Guy said...

Excellent point. If all the money I wasted buying food was converted to stock market returns for the last 24 years of my life, I'd be a millionaire already.

Admittedly, I wasn't eating caviar all the time, but cars are a necessity. Three points here:

1) interesting you picked this post since this is not the car I got

2) cars are a necessity, and while I did overspend, some portion of that was sunk cost since I have to have a car (and no car has a positive ROI)

3) although I agree with your math, $12K can not get 10% investment returns in 7-8 years on average. 10% returns are typically average for large investments of about $500K or more. Consider that the Dow in the last 10 years returned a total of 44%.

Anonymous said...

I know you got a different car, you got the beemer.

I chose this because it was the first car post I came across when I was reading older posts.

Just different views I guess. My fiancee has to commute an hour to work each day, so I understand cars being a neccessity... however, when we bought him a car we got a used model for under 8k and paid 100% cash for it. It looks sleek and drives well/is reliable(admitadly not a sports car)

Yes, it will continue to decline in value as all cars do, but we didn't do into debt to get it. It would have been easy to finance a new 20-40k car but I feel that would have been the stupid thing to do. Why take on extra debt if you don't have to?

If you are serious about your goal of 1million, or even of a goal of just having a positive net worth by age 30, you should have paid cash for a car and not gotten yourself into just another payment and loan to pay off.

Again if you are serious you would not spend much on food either, caviar or otherwise. (I understand that was supposed to be a sarcastic reply) You would make food minimal and eat rice and beans as long as needed, not going out to bars and restaurants, you would have a budget and actually put every penny towards debt/net worth.

Also - 99% of 5 year periods the dow ended with a + return, while ~1% of cars end up that way. So, you could get a 10% increase for 8 years, definitely a positive change, just being in a good mutual fund..

Finance Guy said...

To some degree, I agree with you and many other commentators that my car is a luxury rather than a need. I have also expressed this sentiment.

Frankly, at the core of any financial matter, many of you are absolutely right. Necessities should be paid for at the cheapest possible price point.

However, I consider it in two ways:

1) As I have blogged before, the nature of finance (high finance, as opposed to classic bean counting and report-cranking finance), necessitates such a status symbol.

2) I consider it an indulgence (and frankly a rare one) when you contemplate the many things I could be buying.

Consider that my true savings per month are about $200 in cash and $400 in my 401(k), a savings rate far higher than national averages of any country. In addition, I pay down long-term debt (car + student loans) at a rate of $1100 a month.

To answer the more fundamental issue, at the current rate, I will have positive networth in 3-4 months and reach $1 million in liquid assets 23 years from now, or 16 years later than my goal, using conservative estimates.

The goal is very dependent on better than conservative increases in investment returns and salary increases. The goal is tough, but that is why I have the goal.

Running my model, the total impact of the car is about a 2-3 years difference. This is something I struggle with.

Maybe it is also a lesson learned.

But what's the alternative now? I would certainly lose more money by selling it and buying a cheaper car.

Leslie said...

1) As I have blogged before, the nature of finance (high finance, as opposed to classic bean counting and report-cranking finance), necessitates such a status symbol.

Here I disagree again. I know many millionaires who drive used cars, and many NYC executives (including some in my family) who have nice cars but nothing as extravagant.

Finance Guy said...

Leslie, what is your main point?

I feel like this entire discourse has been to satisfy some deep-rooted hatred for either the car or my ability to buy the car.

What is it that you want to have happen?

Are you looking for me sell the car and wear a sign that says "Leslie was right"?

Honesty, I just don't understand your point.

Leslie said...

Finance Guy: Sorry, I guess I did come across a little ranty. I misunderstood your goal of 1mil in liquid assets to mean debt free as well. I guess since you have no intention of being debt free by 30, or at least it isn't part of the main goal, then selling the car (even buying it in the first place) wasn't too bad. If it were me I would sell it yesterday and cut my losses to pay off student loans etc.

I don't have a hatred for your car or your ability to buy it. I could have bought a car like that as well, I definitely have the income and I love BMW's - my dad has two.

I am also a 20something just starting out after college, and I have only been reading your blog since January 08. (I thought I'd read the first month's posts to see where you started back in Feb 07 - and this was my first set of comments) I guess I just hate to see other young people doing things I consider stupid. I didn't mean to offend - I just was rooting for you to make your goal (or close to it) and saw someone who (IMHO) was going down the wrong path. Best of luck with everything.

I will continue to read your blog, maybe even start one of my own soon.

Long days and pleasant nights,