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Recently I wrote about buying a home and said that, while it is not the best investment, there are emotional reasons for buying instead of renting. But we should certainly be smart about how we buy a house. This week I want to focus on what is likely our second-largest monthly expense (after a home loan) – a car.
We can argue about whether buying a home is an investment or not, but nobody would say that a normal car is an investment. A car is a depreciating asset and shouldn’t even be called an asset; it’s a liability that offers some utility in that it enables us to get around independently.
The first problem buying from a dealer is that it includes VAT of 14%. But when you sell it or trade it in you cannot charge that VAT. So immediately you are well behind the curve on the car’s value – before even driving a new car off the lot and seeing its price plunge, as it’s no longer brand new.
Aside from the instant, large loss we incur, we need to watch what we spend. Maybe you can afford a R5 000 car payment every month. But what if you only spent R4 000? You’d still have a nice car and R1 000 to invest every month. Depending on your age, you’ll be making car payments for a number of decades. If we assume that you make 30 years of car payments, a saving of R1 000 per month means you’ll save R360 000 over your lifetime. This number is not adjusted for inflation, growth or future value of money, but it is still a large sum and all you did was slightly shop down on your car. Why not?
Importantly the monthly payment is not just the cost to repay the loan. It also has to include insurance, running costs and servicing. Maybe you got a service plan included, but that wasn’t really free, you pay for it somewhere in the cost of the car.
Your first car will likely be bought on credit unless you’re buying a rust bucket. Ideally, though, your vehicle should be reliable and safe. So for your first car, sure, you may want that luxury German sedan or fancy SUV, but work out what you can afford and then drop one level down. Get the slightly less fancy car, which will immediately have you saving some money every month. The ideal is ultimately to buy down and pay cash, driving the car until it almost gives in.
Importantly, never lease a car and never opt to make those lump-sum balloon payments on completion of the loan. Balloon payments reduces monthly payments but significantly increase cost of the car overall as you’re charged interest in the balloon every month. Also: do not pay the car off for any period longer than four years.
After four years the car is paid off, but it is still perfectly good for driving, so keep driving it and save what you would have been paying every month. After another three or four years of driving your now paid-off car, and you’ll have a large deposit for when you buy your next car. Again buy down and pay it off over four years (or less), keeping it for another couple of years after you have paid it off.
Now when buy your third car, you may have enough cash and trade-in value to not need a loan. If not now, then certainly your fourth vehicle will be loan-free. And with that, you are no longer wasting money every month on a depreciating asset. Sure, you still have running costs, insurance and upkeep, but your monthly car bill will be significantly smaller than those paying full value, and you have thousands to save and invest every month
This article originally appeared in the 10 November edition of finweek. Buy and download the magazine here.
