"Make it your mission to understand & invest wisely. Everyone has the potential to succeed in their search for true wealth & happiness & everyone can be successful in their pursuit of financial freedom." Contrarian Invest

Monday, 10 September 2012

What your car is really costing you?

I’ve noticed that many South Africans seem to be especially good at spending astonishing amounts of money on their vehicles. With the recent price hike in fuel prices many people don’t realize just how much it really costs to own and drive a car. 

Owning a car is expensive. 5 years ago i opted to purchase a stable entry level vehicle and invest the money that i would have paid in car installments for a new vehicle into a high growth investment fund instead. My thinking behind this was in about 5 years time my investment fund would have grown significantly in value. It would be wiser to use that money to purchase a new vehicle instead.

That way i am using my assets (Investments) to purchase my liabilities (vehicle). Imagine that instead of spending R10,000 per month on a vehicle instalment  per month, you instead settled for a stable entry level vehicle with a repayment of about R2000. That's R8000 per month 'opportunity cost' that you could invest & put away for your future. R8000 x 60 months = R480,000 excluding growth earned! What is that sacrifice worth to you today?

Biggest cost is the car payment, right?

Wrong. This is probably the biggest mistake people make when they think about what their car is “costing” them. The truth is that your car payment has almost nothing to do with what your car is costing you.
The biggest expense for most car owners is depreciation – how the car looses its value over time. This is especially true for expensive luxury cars, and cars that are less than five years old.

Some examples

There are two types of costs involved with cars: ownership costs (the costs you have just by owning a vehicle), and running costs (the costs of filling up, maintenance, etc.).
The table below shows the real monthly costs for four very different types of cars, taking into consideration the next year, for someone who drives an average of 2000 km/month.

2008 BMW
320d
2005 VW
Polo TDi
1999 Volvo
S40 T4
1999 Fiat
UNO Mia
Ownership Costs R 10,579 R 3,654 R 1,704 R 771
Running Costs R 1,506 R 1,922 R 3,550 R 2,067
Total Monthly Cost R 12,085 R 5,576 R 5,254 R 2,838
For the calculations I used a R25,000 cash deposit, with the rest of the capital needed to buy the car financed at an interest rate of 15%, a return on the next best investment (opportunity rate – see rest of post for explanation) of 12%, and the cost for one liter of fuel: R11.

Before I continue, here is some information about the cars I used for my examples (the second hand values of the cars, and the values for the rate of depreciation over the next year were estimated by looking at actual prices of vehicles advertised on the AutoTrader website):

2008 BMW
320d
2005 VW
Polo TDi
1999 Volvo
S40 T4
1999 Fiat
UNO Mia
Current Value R 330,000 R 120,000 R 60,000 R 25,000
Rate of Depreciation 20% 15% 10% 10%
Fuel Economy (km/l) 18 18 10 15

Ownership Costs

The ownership cost of a car will be roughly the same, whether you drive 4,000 kms or 1,000 kms a month. The number of kilometers you travel will have an influence on the depreciation of your car, but compared to the influence of time on depreciation, it is not even worth considering.
The ownership costs of a car are:
  • depreciation – how your car looses value over time,
  • finance costs – the interest you pay on your car loan,
  • opportunity costs – the amount you could have earned or saved, had you done something else with the money you’ve already paid off on your car,
  • insurance costs – accident and theft cover, and
  • miscellaneous costs – registration, overnight parking, etc.
The estimated yearly ownership costs of the cars used in my example are:

2008 BMW
320d
2005 VW
Polo TDi
1999 Volvo
S40 T4
1999 Fiat
UNO Mia
Depreciation R 66,000 R 18,000 R 6,000 R 2,500
Finance Cost R 45,750 R 11,250 R 5,250 R 0
Opportunity Cost R 3,000 R 3,000 R 3,000 R 3,000
Insurance R 12,000 R 8,400 R 6,000 R 3,600
Miscellaneous R 200 R 200 R 200 R 150
Total Yearly
Ownership Cost
R 126,950 R 43,850 R 20,450 R 9,250

You should notice from the table above that depreciation is the biggest ownership cost for all the examples, except the very cheapest car.
The thing that makes depreciation difficult to comprehend is that it is not something where you can see the money disappearing from your bank balance at the end of each month. It’s more like that where did all my money go? feeling you get a year or two later.

Another cost that is difficult to grasp at first is the opportunity cost of your car. Your opportunity cost is the amount of money you could have made from your next best investment, had you invested the money, rather than spend it on a car.

If your car is worth R100,000 and you’ve paid off your car loan completely, and your next best investment was to not actually to invest the money anywhere, but to rather pay off a part of your home-loan, on which you are paying 12% interest per year, then the opportunity cost of your car is R100,000 x 12% = R12,000 per year.
The opportunity cost of your car is the amount of money you would have had extra, had you invested your money elsewhere, rather than spend it on a car.

Running Costs

The running costs of a car will vary depending on the amount of driving you do. The more you drive, the more you have to fill up, and the more you have to spend on maintenance.
Your car’s running costs are:
  • fuel – filling up the tank,
  • maintenance – keeping the car serviced and road worthy, and
  • miscellaneous costs – toll fees, car washes, traffic fines, parking fees at parking garages, money you give to car-guards, etc.
The estimated yearly running costs of the cars used in my example are:

2008 BMW
320d
2005 VW
Polo TDi
1999 Volvo
S40 T4
1999 Fiat
UNO Mia
Fuel R 14,667 R 14,667 R 26,400 R 17,600
Maintenance R 1,000 R 6,000 R 15,000 R 6,000
Miscellaneous R 2,400 R 2,400 R 1,200 R 1,200
Total Yearly
Running Costs
R 18,067 R 23,067 R 42,600 R 24,800

What we can see here are – as can be expected – that older cars are more expensive to maintain, and that cars with worse fuel consumption will cost you more in fuel. That’s pretty self-explanatory.
However, what should be striking you more is that the fact that the running costs of the newer and more expensive cars, are positively dwarfed by the costs you incur simply by owning them.

What to make of all of this

The first thing I hope you’ve learnt from this post is just: cars are expensive. Do you really need a car? If you want to save money quickly, it may be a good idea to sell your car, and share with someone else, use public transport, or buy a motorcycle or scooter instead.
The second thing I hope you’ve learnt is that usually older cars are cheaper, even cars that have high maintenance costs and relatively bad fuel consumption.

E.g. look at the difference between the 2005 VW Polo TDi, and the 1999 Volvo S40 T4 in my examples. The Volvo has much worse fuel consumption, and high maintenance costs – but it is still cheaper than the Polo!

And finally…

I hope it’s helped you understand the real costs of owning and driving a car, and that you will be able to make a wise choice the next time you want to upgrade or change your vehicle.

No comments:

Post a Comment

Warren Buffett Quotes

Leadership Quote of the Day