I admit it openly and publicly now, I drive a car that is 8 years old. Embarrassing isn’t it? Even though it’s a nice car, Mercedes CLK 430, it’s still 8 years old.
Seems like I’m in good company though.
What car do you drive..? Or more to the point, is the car you drive likely to keep you broke for the rest of your life?
Read on on, you’ll find this very interesting and perhaps a little bit painful too.
There are lessons here…
It’s not hard to spot the product of new wealth: a luxury car in the driveway or a huge home in the suburbs.
This new millionaire is attached to expensive toys and bank account statements, loving every minute of the million dollar dream. We’ve all seen these people, and their outward appearance literally screams “new money!”
However, the true millionaire or billionaire – those that come from the product of old wealth or their own well timed investments – tend to live a toned down lifestyle.
Look into the driveways of the founders of IKEA and Walmart, and even Warren Buffett. There are no luxury automobiles here, but used Volvo station wagons and second-hand pick-up trucks.
Treating each purchase as an expense.
The millionaire lives in his or her own environment, where every purchase and expense is calculated to the smallest of numbers.
Why buy that $40,000 car that gets you to the same place in the same amount of time as a $5,000 used station wagon?
Furthermore, many upper-end cars are financed at rates that exceed the amount that can be made by safe investing, proving that consumption doesn’t pay.
The biggest difference between the millionaire and the newly rich is more psychological than any other element. A millionaire, who grew his or her own wealth, understands the power of money and how it can work for them – not how it can cost them.
In this example, it’s easy to spot the folly of purchasing a depreciating asset with a line of credit.
Purchases, such as cars or pricey electronics, lose value over the long term. A new car when driven off the lot loses 30% of its value because it is now classified as a “used” car.
As mileage racks up, the car loses some utility and falls in price to accommodate. A car or luxury items should be classified as an expense, rather than an investment or asset.
Short term risks of depreciating assets
One of the biggest risks in borrowing to buy a depreciating asset is going upside down. For example, if you were to purchase a new $30,000 car, and then total it just a year later, the car would be worth only $24,000 considering the best possible outcome.
In this case, an insurance payment would be for the amount of $24,000, but the car would still have liabilities greater than its current value.
Your cost of ownership would equal out to around $6,000 per year, which is $500 per month to essentially rent an invisible car. You would no longer own the car, but instead be left with a debt of $6,000.
Financing a depreciating asset further compounds the problem. In many instances, car owners find themselves “upside down” or owing more on the car than the actual value.
As a car depreciates in value by an average of 7% – 12% per year, and interest charges account for another 5% – 6%, the car actually devalues itself by up to 18% per year.
Even more, if the car is bought brand new, it can lose 40% of its value in just the first year. Quite simply, a depreciating asset is an expense, while an appreciating asset is an investment.
The danger of borrowing for a depreciating asset is apparent. A car may lose 18% of its value in one year due to interest and depreciation, while a home will appreciate in value with the cost of borrowing.
No millionaires will ever be made from investments in depreciating assets, especially when combined with financing.
Only appreciating assets should be financed, and even then, there must be some due diligence paid to the future value of the investment.
Jim Walton, heir to the Walmart fortune, drives a 15-year old Dodge pickup truck.
Ingvar Kamprad, founder of IKEA, sports a 15 year old Volvo station wagon.
Warren Buffett, with $52 billion in assets, drives a 2006 Cadillac.
Sergey Brin, founder of Google with $16.6 billion in assets, is seen around the Silicon Valley in a humble Toyota Prius.
Get the picture? Make your assets work for you, and your bank account (and heirs) will thank you.