Most readers of this blog are probably not pulling in $60-70k yearly salaries. If you’re one of the lucky ones that graduated with a professional degree and ended up getting a high paying job, then this post speaks to you. If you’ve slowly built up your finances and feel that you are ahead of the game, then this post might also apply to you. With success comes the need to show it. There isn’t anything more that screams “I’m rich” than rolling up in a brand new luxury car.
In North America, the car has ultimately become the symbol of wealth. Regardless if the person bought the car on credit, or makes monthly payments for the next 7 years, driving and owning a luxury car such as BMW, Mercedes, Lexus or Audi has become the symbol of prosperity and wealth. Aside from owning a home, a luxury vehicle proclaims to the world that “I’ve made it!”
A luxury car may bring fame, status and attention, but what it doesn’t do is build wealth. Everyone would tell you that a car that comes off the dealership lot loses 30% of its value the moment the wheels hit the pavement outside of the lot. It’s no guess that in order to build personal wealth, one needs to save and invest in assets that appreciate in value rather than depreciate. Once you gotten yourself off the ground and started building a nest egg, the worst purchase that one can make is a brand new luxury car that drains you of the only asset you have that can generate wealth passively: Your money.
This doesn’t mean that you should not buy a car at all. Each person will have specific needs and a car might be one of them; however, when considering that a car is the single biggest depreciating asset you will ever buy, it makes more sense to buy a more economical vehicle or even buy a used one instead. So what’s the difference when you buy a brand new luxury car versus a lessor solution? Let’s find out.
Luxury vs Simplicity
For this example we use a brand new basic BMW 3 Series sedan with no down payment financed over 5 years. The total cost of owning the vehicle is $46 000 in Canada. The resale value after 5 years of the basic BMW 3 series is around $17 500 based on Auto Trader prices. This is the assumed value of the car after 5 years. The monthly cost of owning the vehicle is $766 for the next 5 years.
An alternative more economical vehicle might be the popular Honda Civic where a basic version of the vehicle has a total purchase price of $20 000. A used Honda Civic of 5 years old on Auto Trader current sells for around $9 500. The monthly cost of owning the Civic is $333 for the next 5 years.
The assumption made in this example assumes that the person has no money to start with, but can make all payments on the vehicle over a 5 year period. The money saved from purchasing the lessor vehicle is saved and invested at the end of the year in a very conservative balanced, diversified portfolio making an average return of 6% annually. So how much ahead is the individual after 5 years?
Buying The Luxury Car
If the luxury car was bought brand new out of the lot and that was all that was left, then the individual would have $17 500 at the end of 5 years as their net worth. This is the remaining value of the car based on the resale value of the vehicle.
Buying The Simple Car
By buying a more economical car, it allows the individual to save and invest the difference. With a small return of only 6%, the money saved turned into $29 078.24 after 5 years. Considering that the simple car cost $26 000 less, the individual was able to make more than $3000 with the money saved. No bad.
Add the final resale value of the car of $9 500 and the individual who bought the simple car now has a net worth of $35 500. That’s more than double the net worth of the individual who bought the luxury car!
Long Term View
One of the most overlooked aspects of saving in your early years is the impact down the road that the money saved may have. Imagine if the individual in question did not invest anything more for the next 25 years. What would that $29 000 turn into with a return of only 6% per year: $124 464. Holy shit! That $5 000 saved each year over a 5 year period turned into a difference of almost $125 000 after 25 years.
So what would happen if the person who bought the luxury car wanted to get the same amount of money as the other individuals with only 5 years of saving? Since the individual who bought the luxury car started saving 5 years later, this person would need to save $7 500 each year for five years and invest it at 6% to equal the same amount of money as the person who bought a cheaper car. So how easy is it to save $7 500 a year once you’ve gotten a taste of driving fancy cars and keeping up with the Joneses? Pretty hard I imagine.
Does driving a Honda Civic versus a brand new BMW make you a lessor person? Are you invisible to the world just because your vehicle is not made in Germany? We probably all have dreams and goals of attaining all the luxury wants that we can think of. As a person who is young in their career and trying to build an investment portfolio, it pays, literally, to make the proper financial decisions when you are younger rather than when you are older.
Remember that the generation before didn’t have the same type of wealth as the current generation did. Helicopter parents have provided a much higher quality of living than can possibly be imagined a generation ago. Make the right financial decisions to protect your wealth the same way your parents did.
Use the power of compound interest to your advantage. The earlier you can start building an investment portfolio that will build wealth for you, the better off you will be. Ultimately, we all want to have some fun in our lives, but waiting that extra 5 years actually makes a bigger difference than people think.