May 23, 2010

Why Millionaires Don’t Have Great Cars (or the REAL cost of owning a car)


I know quite a few pretty wealthy people, and many of them live in luxury and opulance. The way they got rich is through a combination of luck, smart tactics, strict goals and really hard work. They see money as a tool which can be used for many purposes, some productive – others destructive.

However, I have noticed that a lot of the time the value of the cars their own is absolutely miniscule to the value of their assets, and I know a person with a multi million rand home that drives a Toyota Yarris. Sure, there are those with the Ferraris and Lamborghinis, but they see those cars as pure luxury expenses.

I decided to look deeper into this, and it turns out that a car is an incredibly bad investment – its the worst liability a person can typically buy into in their lives. We all know this intrinsically, but I put some math into the works to see how much a car actually takes out of your pocket.

My student car

When I entered varsity, my dad bought me a good old Hyundai Accent ’98, affectionately named Clarissa. It cost him R30,000 (about $4,000), and I promised to pay him back one day. The monthly cost for insurance and petrol was around R650, and it was serviced a couple of times through-out three years. The yearly maintenance, licensing and fine costs amounted to about R2,250 per annum. If I were to sell the car after three years, with 8% depreciation, the total cost to me over 3 years would be:

Cost = 30000+2250*3+650*12*3-30000*(0.9)^3 = R38,280

As you can see, the cost of just owning that car for 3 years is already more than the cost of the car! But wait, what if – as an intelligent investor – I opted to invest all that money instead of buying a car? How much would I have after three years? Assuming a modest 10% return per year:

Investment = 30000(1.1)^3+2250(1.1)^2+2250(1.1)^1+2250+(650*12)(1.1)^2+(650*12)(1.1)+(650*12) = R73,195

Wow! If I chose to invest all the money that had gone into owning my car into a 10% fund instead, I would have R73,195 after 3 years. Instead, I opted to own a car and lost R38,280! That means the total swing is over R110,000 ($14,600) for a R30,000 vehicle. If I have a Ferrari costing 100x as much, the swing would be almost R10 million under the same assumptions.

Of course, I ignored the pure and simple fact that owning a car in South Africa is necessary due to the bad public transport system, and even without a car the cost of public transport would still need to be taken into account. But regardless, it is pretty obvious to me that owning an expensive car is one of the worst financial decisions a person can make. Unless you don’t view it as an investment of course, and understand that the losses you incur far outstrip the value of the car your buy.

30000(1.1)^3+2250(1.1)^2+2250(1.1)^1+2250+(650*12)(1.1)^2+(650*12)(1.1)+(650*12)
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22 Comments

  1. Lee Provoost May 23, 2010 at 4:09 pm

    best way to view it is to have a car that you really enjoy. before i moved to london i had a company car and opted to spend a bit more of my own budget for luxury. why? because i spend so much time in the car that i wanted to give myself that little extra

    worth the money? not from an investment point of view of course. but from personal pleasure: priceless!

    so unless you have a classic, cars and reason don’t belong in the same sentence… :)

  2. josh May 23, 2010 at 4:14 pm

    The problem is here in the US, you have to have a car to get around, most of the time. Unless you live in dense cities, like New York or on the West coast, public transportation sucks and you have to go 30 or more miles just to get to work.
    For instance, I live in La Vista, Nebraska just outside of Omaha. The Omaha bus system comes through twice a day, once in the morning and once at night. I work different times everyday and at least once a week work until 9pm. I have to take the hit and own a car to make money.

  3. Party Pooper May 23, 2010 at 4:26 pm

    10% is a very good return. It’s anything but “modest”, certainly is not conservative and makes me wonder what kind of business plan you wrote for your startup.

    Also, just an FYI that everyone knows buying a car is a loss from the second you drive it off the lot.

    My advice: Go back to Varsity and take an economics course.

  4. Art May 23, 2010 at 4:26 pm

    Calling a car an investment and not an expenditure is just plain wrong and I’m afraid, if you check further, you will find that most wealthy people spend more on cars than not so wealthy people. Your argument might be a bit flawed.

  5. Giles Bowkett May 23, 2010 at 4:39 pm

    Josh, re: the West coast, Portland has great public transit, and I hear good things about Seattle, but LA’s public transit is only good for short distances and SF’s public transit is not good for anything. It’s an embarassment to humanity and people from the former USSR say it reminds them of the Soviet era.

    Mike, my dad had a Ferrari when I was a kid; I don’t think he was ever a millionaire, but he did start a successful business from his garage, and that business (no coincidence) was fixing cars. Later he expanded to brokering vintage cars internationally, and I can tell you, there are so many millionaires buying great cars that you can feed a family and live in comfort on nothing but the finders’ fees.

    However, I don’t think my dad would have bought that Ferrari if he didn’t know how to maintain it by hand. The poverty that makes cars expensive is the same poverty that makes anything expensive: information poverty. Luxury cars carry absurd, gigantic maintenance costs beyond their initial purchase, but for a seasoned mechanic with 5 or 20 employees (no idea the actual number), plus access to suppliers at wholesale or below, those costs are way lower.

  6. Professor Doctor Pants May 23, 2010 at 4:54 pm

    Isn’t assuming 10%/year returns in the stock market a bit much? I could see 10% *over* 3 years, but unless there’s a boom (or bubble) afoot in SA, that’s an unrealistic expectation.

    Just a quibble, though. I agree that we ignore the high costs of cars. Assumptions built around car ownership and use also ends up costing everyone more in several hidden ways: http://www.youtube.com/watch?v=l_O6dR7YfvM&feature=player_embedded

  7. Sami May 23, 2010 at 5:02 pm

    How about 2 wheelers? They must be really light on the pocket. They are especially suitable in areas with a moderate climate -or, when the weather is moderate.

  8. Emerson May 23, 2010 at 5:07 pm

    If you need to have a car then the question isn’t whether you buy a car or not it’s how much you spend on it in the first place and how long you drive it. I’ve had my Ford Focus, that I bought new in 2000, for 10 years and 150,000 miles. I’ve definitely spent less (on maintenence) than my friends that bought new cars every 4-6 years.

  9. Mac May 23, 2010 at 5:16 pm

    First, you forgot Inflation. Your R110000 are /2013/ Rands, which is a irrelevant figure because it does not say what they will buy. Assuming a 5% Inflation then R110000/(1.05^3)=R95073 is the price in today’s terms.

    Second, you assume a bullet proof 10% fund for your example, I am quite sure that the news of a global financial crisis has spread to South Africa as well, so we all know by now that these funds sometimes default and the such. So instead of some somewhat risky 10% interest from a murky fund, you should take the interest for a gilt-edged investment with zero default for your example or factor in the price for a CDS.

    And third, there is a fundamental problem with your argument: Assuming you don’t buy the car but save instead. What are you going to do with your money after three years? Buy a car? Probably not, because then you’d have the same problem with opportunity costs then. *Consuming* means that you loose money what you could get from *saving* instead. So unless your plan is to become a stingy old rich bastard who plans to terrorize his potential heirs with the prospect of a possible fortune, you loose money if you enjoy your wealth.

  10. Mike May 23, 2010 at 5:16 pm

    @Lee: Expensive cars must be viewed as a luxury expense

    @Party pooper: You are entitled to your opinion, but I always use facts and math to back up my data. http://en.wikipedia.org/wiki/S%26P_500 shows the median return of the S&P as almost 11% for the last few decades.

    @Emerson: Exactly, I just wanted people to know the actual amount lost from owning a car, which many people don’t fully understand. We all know its a loss, but the question is how much.

  11. Guy Gur-Ari May 23, 2010 at 5:19 pm

    Your calculation is not precise. The swing is (profit – loss), but you’re calculating (balance – loss) and you get some exaggerated numbers.

    Suppose there is no maintenance, only depreciation. If you buy a car your loss is 30000-30000*(0.9)^3 = 8130. If you invest the money your profit is 30000*(1.1)^3 – 30000 = 9930. So your swing is about 18000, not 48000.

    (IANACPA :)

  12. Peter Donis May 23, 2010 at 5:55 pm

    Re the S&P rate of return, the median is not the right number for the calculation you made. The right number is what the Wikipedia page calls the CAGR (compound annual growth rate), which is 8.80%.

  13. Kiran Jonnalagadda May 23, 2010 at 6:34 pm

    @Party Pooper: maybe you’re in the wrong part of the world. 10% is the minimum I expect of any of my investments. Anything below that is a loss, considering the inflation rate.

  14. statsman May 23, 2010 at 7:43 pm

    @OP

    You math concerning the investments is incomplete at best, quite misleading at worst. If we begin to consider the tax implications of car ownership or capital investments your theory goes out the window.

  15. SD May 23, 2010 at 8:02 pm

    Guy Gur-Ari is right, your swing is 30000 too high.

    If I’m debating between spending $10 or not, my swing is $10 (spending $10 vs gaining $0), not $20 (spending $10 vs having $10).

  16. LY May 23, 2010 at 9:45 pm

    to Professor Doctor Pants:
    > Isn’t assuming 10%/year returns in the stock market a bit much?
    In South Africa, you can easily and safely get 10%/year returns by simply depositing your money in a bank. That’s 2008, in 2010, I believe a fixed deposit interest decreased to 7% or something.

  17. Duff May 24, 2010 at 2:46 am

    @Sami: Motorcycles are cheap to operate — the used market for motorcycles is great, and gas and insurance costs are low.

    Think of why these are are the way they are:

    – Gas is cheap because they are light with small engines.
    – Insurance is cheap because riders tend to die (which is cheap) versus get hurt (which is expensive) in the event of an accident.
    – Used purchase prices are great because wives/girlfriends force their significant others to get rid of the things before they kill themselves.

  18. Stephen - Rat Race Trap May 25, 2010 at 11:53 am

    Hello Mike, people can quibble about the math, but the point is the same. A car costs money and the questions are should you buy one, how much should you spend, and how long you are going to keep it.

    What car you buy matters a great deal because the cost of operation varies a lot. Some more expensive cars are cheaper in the long run because of resale value and cost of operation.

    I used to buy new cars frequently. Now I buy them less frequently. Oddly enough just today I thought about this and decided I was going to buy them even less frequently in the future. For me at my age it’s no longer a question of saving vs. spending, it’s a question of what I want to spend my money on. Cars and other things are no longer appealing to me. I realize that the thrill of a new car was short lived and it soon became just a car. I would rather spend that money on experiences that matter to me. On my deathbed I don’t think I will be saying “I wish I had spent more money on cars.”

  19. Mark Schonrock June 10, 2010 at 11:34 am

    Wow – sounds like investment and cars is a HOT topic in everyones book – haha. I love how opinions vary and somehow we ALWAYS think ours is right.

    I think cars, expected rate of returns on investments, inflation expectations and hot chicks are all personal views and/or desires and we will always vary on these, so lets agree to disagree.

    Great blog – really invoked some good debate!! :P

  20. Alex August 5, 2010 at 2:07 pm

    I own a car and live in South Africa, and I fully agree that owning a car basically has a black hole effect on one’s finances. What I found interesting though is that nowhere did you account for the fact that in South Africa (and many other places on this planet), you would have had to “invest” a substantial amount of money over those 3 years in alternative transport. That is, you would not have been able to invest everything that you spent on the car (and used in your investment return calc).

    So while the investment return might still have been positive, it would surely have been decimated by alternative transport costs!

  21. Lee Clarke November 21, 2010 at 10:11 am

    Great article just down graded from my Double Cab and V6 sports car to Two Smart for twos ….I now get 20km per lite of fuel great advertising as i am a a member of the Rawson Property Super brand and the calls just keep on coming.

    Good luck with you Blog and keep the advise coming

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