One of our theme goals of this blog is improving the impact of our giving. One obvious way that we can making a bigger impact, is simply by saving more money so we can give more. We were recently in the market to buy a car, and I did a lot of research on the various costs of car ownership and the different ways we could reduce our expenses. Here are some of my findings, in case it might be helpful to you down the road. This research and the suggestions are focused on how to reduce costs of car ownership; I certainly recognize that people find value in cars beyond just getting from point A to point B as cheaply as they can, and so you can consider these suggestions in light of your own priorities. However, I believe that making an effort to reduce our expenditures, in this very costly portion of our lives, and giving the saved money to a good cause can truly have an tremendous impact, and literally save numerous lives.
The cost of car ownership is the second largest household expense for the average American family ($7,677 or 12.29%), according to the Department of Labor. The largest monthly expense is housing, and for home owners some or much of this expense is actually an investment, going towards equity, and creating tax deductions. Consequently, for many if not most, American households, car ownership is the single largest cost in terms of real loss of equity, more than clothing, entertainment, or food. If we want to pursue living simple, low-cost lives so can we be free to be more generous, reducing car ownership costs is one of the greatest opportunities we have to free our finances.
The economics of car ownership are not necessarily all that simple. Most of us know that buying a new car is very expensive, and obviously a less expensive used car will cost us less up front, but most of us also understand that simply buying the cheapest, old clunker car is probably not a good investment; the repair and maintenance costs of a very old car might be higher in the long run. But what is the optimal best choice for a vehicle, that minimizes our cost of ownership?
First, it is helpful to understand the major costs that make up the total cost of ownership. For most vehicles the number one cost is depreciation. In terms of ownership, it is helpful to talk about depreciation instead of purchasing cost, because your car has equity that can be converted back to cash when sold, but depreciation lets us see the rate that the equity is being lost. Depreciation also allows us to compare with other yearly costs. As a general rule, depreciation is about 15-20% of a car’s value per year, but this can vary. A brand new car experiences far more depreciation initially (closer to 30% for the first year), and older cars tend to slow down somewhat. Also cars that have a good reputation for reliability tend to depreciate slower, like Honda and Toyota. But in general depreciation is proportionate to the value of vehicle, so the cheaper a car is, the lower the depreciation.
There are a number of other expenses that are also related to the value of a vehicle, including interest, insurance (at least comprehensive), and taxes.
The second biggest expense is gas. Obviously the best way to reduce this expense is get a fuel efficient car. For most cars, particularly newer ones, fuel cost is several times more expensive than maintenance and repair. Generally this is pretty constant over the life of a vehicle, but often newer, more advanced vehicles can squeeze out better mileage.
While these other expenses tend to decrease or remain constant as a vehicle ages, one expense definitely does increase with age, and that is the repair costs. So at what point does the repair costs start to outweigh the other expenses (or more precisely, when does the marginal increase in repair exceed the marginal decrease in value related expenses)? I wanted to try to estimate this, so to calculate this I put together a spreadsheet of the various different costs of a vehicle and the rate they change over time (as a disclaimer these are certainly rough estimates, most of my data came from Consumer Reports, but different vehicles undoubtedly vary in their expenses). I then totaled the expenses and charted it here:
There are a number of lessons from this chart. First, the initial year of car ownership is literally off the chart (it was about $13,400). Buying a new car simply does not make good financial sense.
As you can see from this chart, the low point of car ownership doesn’t occur until about 14 years, after the car is less 10% of it’s original value (in this chart the car, is approximated to have initial new sale value of $25,000, and at this point has depreciated to being worth $1800).
Of course you probably aren’t going to keep every vehicle for only one year, and sell it. In fact transaction costs of buying a vehicle are also significant, particularly if you live in a state with a sales tax and/or you are not very shrewd when it comes to haggling and finding the best deal. In fact these transactions cost are usually high enough that, in general, it is best to keep a vehicle as long as possible. Upgrading is seldom economically beneficial, unless you are doing so to improve mileage or get out of a car with known expensive upcoming repair needs.
And if you are going to own a vehicle for a number of years it makes sense to buy before the bottom of the curve, probably an 9-10 year old vehicle is optimal, but as you can see even a 7-8 year old car, which may be nicer, is still quite near the optimal cost level.
There are other intelligent ways to reduce the cost of ownership besides buying an older, but not too old car. Again, the second biggest expense is fuel costs; a fuel efficient vehicle should be a top priority for the economically-minded buyer. Certainly the biggest determinant in fuel expense is the size of the vehicle and the size of the engine. Large SUVs almost always get much worse mileage than smaller sedans. SUVs also have higher depreciation costs, repair costs, and insurance costs. The cost of ownership of an SUV is usually at least 50% greater than a sedan, which can easily translate to over $2000 a year in ownership costs. Picking the smallest car that can accommodate you or your family’s needs is a key way of reducing your fuel costs. Also, smaller engines simply do better with fuel mileage. A bigger engine may be more fun to drive, but it inevitably costs you at the pump.
The most significant innovation of the modern era for improving fuel mileage is the hybrid. Hybrid drive-trains produce tremendous improvements in fuel mileage, often providing over a 50% improvement in MPGs. Paying several thousand dollars more for a hybrid can usually be very reasonably recovered in reduced fuel costs. However, some classes of cars, particularly SUVs have not had hybrid versions long enough that older, cost-effective models are available yet.
As a personal aside, we recently purchased a Toyota Prius. Admittedly, we bought a newer than optimal car for lowest cost based on the chart (it was a eight years old, but low miles). However, with the dramatic fuel cost reduction, and using the estimate from the spreadsheet, our annual cost of ownership is about $4,500, which is close to even the lowest point of ownership cost for an older conventionally powered car, and after several years our annual cost may actually drop below the low point in this mean chart. And the Prius is fantastic vehicle; it is high-quality and solid, it has great reputation for reliability and resale value, and it is fun to drive. Not only does it have a relatively low cost of ownership, my wife and I both really enjoy the car.
Four wheel or All wheel drive
Four wheel or all wheel capabilities can be necessity in many snowy climates. But these definitely have a cost. The extra equipment involved adds cost to the vehicle (both depreciation and repair) and usually decreases mileage by about 5-10%. Often all wheel drive is pitched as a safety feature, but this doesn’t really make sense. The key safety features for avoiding dangerous accidents are those that help you to turn and stop quickly. Anti-lock brakes and good winter tires are by far the most important safety features for winter driving. Four-wheel drives helps you to go forward in poor conditions, which arguably can get you in more trouble. Still four-wheel drive can be incredibly useful if you are frequently in adverse conditions, and you don’t want to have to constantly chain-up. But, avoid four-wheel drive unless you are in a climate that really requires it.
Buying on Credit
Many financial advisers, like Dave Ramsey, have advised against buying on credit, and I agree with this suggestion. Often times the cost of compound interest is cited as a reason. However, this reason often fails to consider the alternate investment opportunity available. With a low interest car loan, it is actually feasible to invest the money that would otherwise have been given to the dealer, and achieve the same type of positive compound interest that the loan is costing. However, avoiding buying on credit has a far more important implication: when paying with cash we are far more likely to purchase a car at a good economic level. It is far too easy to buy a high-priced vehicle with a high cost of ownership when we look at the monthly payments instead of the real price tag, and we don’t usually have a large amount of money available in our bank account to buy an over-priced vehicle that will tax with large depreciation costs. Consequently, I agree with the advice of avoiding buying on credit, unless you happen to be unusually cunning at being able to leverage credit for better investment opportunities.
But I Need More Room
Indeed, for many, a compact or even standard sized sedan or hatchback isn’t sufficient. But it is worth noting that often times we actually can use a much smaller car than we think we can. Buying a roof rack, car top carrier, bike racks, and other accessories are vastly cheaper ways to carry extra bulky items than carrying around a bulky vehicle everywhere.
But again, for many, a bigger vehicle is necessary, or at least not worth the inconvenience of dealing with a smaller car. This is particularly true for families with more than four kids. I don’t recommend strapping your fourth child to the roof rack! If extra capacity is really all that is needed, you simply can’t beat minivans, as unpopular as that may be. There are a huge selection of minivans in the used market at great prices, and they are usually equipped with engines that generally get better mileage than their similarly sized SUV counterparts.
But of course SUVs do have their place. If you will be towing, going off-road, and need AWD, as well as needing a lot of internal room and capacity, an SUV can accomplish a lot in a single vehicle. And again, engine size matters. Try to find a V6 instead of V8 if possible for your needs. Some mid-size SUVs, like the Toyota Rav 4, Kia Rondo, even have 4 cylinder options, achieving nearly sedan-level fuel efficiency while still offering three row options, although these can be limited to newer, more expensive models.
Constant Cost vs Per Mile Costs
So far we just considered costs on an annual basis. However, much of these costs are not fixed per year, but based on how many miles you drive. Costs like fuel, repair, and to some extent depreciation are based on your usage, and are not just a constant per-year cost. The number of miles you drive can affect the optimal car as well. If you drive a high number of miles, fuel-efficiency should become a higher concern, and a little higher-priced vehicle is more reasonably justified. For a vehicle that will be driven less miles, fuel efficiency is less important, but one should be more hesitant to spend a lot for a low-use car.
Families with multiple cars can also save money by simply being judicious in doing more of their driving with their car that has the lowest cost of ownership. Families with a sedan and SUV can drive the sedan as much as possible, and just use the SUV when the extra space is needed.
Getting the best value in car purchase almost always requires some negotiation of price. This can be intimidating, and many mistakenly think that negotiation requires special oratory skills or the cunning poker skills of bluffs and misdirection. In reality, good negotiation comes down to one basic strategy: make an offer for what would be a great deal, and be willing and ready to walk away if the seller won’t give you what you consider to be a good deal. There are a few important things to do to make sure you are in position to do this. First, research the true value of the any car you are interested in, so you know what is a good price. Second, be prepared to evaluate the condition of the car. If you can’t do this yourself, you can arrange for a mechanic to evaluate it. And third, find multiple cars that you would be interested in buying. If you only have a single car that you want, you are in a terrible position for negotiation, whereas having good backup options makes it much easier to walk away if you can’t get a good deal. When you know what you want to pay, you have multiple cars as possible options, and you are ready and willing to walk away from any one car to look at another, you automatically have the upper hand in negotiation, regardless of how shy you are or how slick of salesmen you are dealing with.
There are plenty of other ways to minimize car costs. Make sure you maintain your car properly, regularly changing your oil. Car pool when possible. Using public transportation or a bike can also help.
You can consider shopping around for the best insurance rates. Liability insurance is required, of course, but collision or comprehensive is not. These types of insurance can provide real value in terms of providing financial stability, but if you can financially absorb the potential cost of an accident, avoiding these insurances can save you some money as well (even with factoring in claims; remember, insurance companies, on average, are making money off of you).
Again, in this post I have specifically focused on how to achieve the lowest possible cost of car ownership, and I recognize that a vehicle is more than just a means to get from point A to point B. There are many other things that you may consider besides just price, including comfort, safety, enjoy-ability, and aesthetics. I certainly understand that you may not want to drive around a 14 year old car because that is very lowest point in the ownership cost curve. And again remember my charts are estimates. Precise data on historical repair costs is tough to come by, and so there is lot of extrapolation that might not be completely accurate. But hopefully, this post can give you some direction on possible ways to reduce your costs, if you are interested in that.
But with these considerations, as a final suggestion, I would challenge you, next time you are considering a car purchase, to either hold off for a while, or try to keep your total investment in your vehicles less than or near 15% of your total income for a year (or 20% if you can get a hybrid). And again, these suggestions are not just for the pursuit of more wealth, but so we can be more generous towards others. By forgoing the purchase of a newer or bigger vehicle, and choosing an older and more fuel efficient model, it is very reasonable for an individual or family to save several thousand dollars a year, money free for other things. As an example, one can give that money to something like malaria-preventing bed nets, and realistically save a child’s life every year with the savings. And that’s better than any safety feature I have ever seen on any car.