Principles of Pollex: Auto Purchases

Photo credit: jb

(In case you are confused by the headline: a principle is a rule, and pollex is an obscure term for thumb. Therefore, this on-going series is all about financial Rules of Thumb.)

Buying a car is such a common activity that many folks don’t give much effort to following any “rules” around this purchase. I’ve often suggested a couple of rules that you may find useful or interesting…

The Decision to purchase a car in the first place

You need to be certain that your decision to purchase is based on a real need. Too often we get caught up in our desires and “keeping up with the Jones’s” when it comes to auto purchases. If your current car is providing you with service and isn’t beginning to fall apart, you should consider delaying a purchase until it actually makes sense for you.

The reason I say this is because a car is a depreciating asset – except in certain cases where you use your car to make money, such as in a delivery business, a car only costs you money – it doesn’t make money for you. And the cost of the car itself isn’t the only cost you’ll incur, you also need to consider additional insurance costs. If you buy a new car, you’ll need to carry full coverage for the replacement of a much more expensive item than your current, depreciated value, vehicle.

But here’s a rule of thumb that you might use to determine the overall cost of owning a vehicle: to get an idea of the total cost of ownership, including insurance, maintenance, and all, double the price and divide by 60. This is a rough guess of the cost, but you can probably do much better by going to a website like Edmunds.com and using their “Cost to Own” calculator.

Suggestions if you’re buying a new car

If you’ve chosen to purchase a new car, here are a few suggestions that will make your choice a better option for you in the long run:

Buy with cash. You should save up and purchase your auto with cash if you can do it. This way you are doing two things for yourself: 1) you’re able to negotiate specifically on the price of the new car and your trade-in’s value; and 2) you aren’t paying someone else for the use of the money.

There are exceptions to this rule, of course. The first is if you don’t have the cash available, which means one of two things, either you will need to delay the purchase or borrow the money to buy. Delaying is a good choice if your present auto still meets your needs (see my comment above regarding the decision to purchase a car in the first place).

Don’t finance for more than four years, preferably three years. In today’s world it’s possible to finance a car for 72 months, or six years, or longer. But if that’s the only way you can afford to make payments, you’re taking on more than you can really afford. This is because of the fact that a vehicle reduces in value dramatically over the first two or three years, and if you finance for much longer than three years, by the time you’ve reached the point where the car is starting to cost a lot of maintenance money (and therefore you’re thinking of trading for a newer model), it is worth much less than you still owe. This is known as being “upside-down” with regard to the financial value of the vehicle.

Put at least 20% down. This rule of thumb is helpful to ensure that you aren’t financing more than necessary. This will also help you to follow the four-year (or three-year) rule above, all the while keeping your payments lower. Just the same as in the “buy with cash” recommendation, if you can’t put at least 20% down in payment at the purchase, you should delay your purchase until you can do so.

Buy a used car

Another, possibly the best, rule of thumb with regard to auto purchases is to buy a used car, and drive it until it literally drops from exhaustion. It may not be glamorous (what sound financial advice is?) but this is one of those recommendations that has passed the test of time, and has been a part of some of the world’s greatest financial success stories.

According to Stanley and Danko’s seminal book “The Millionaire Next Door”, in the chapter called “You Aren’t What You Drive” – the average millionaire doesn’t put much value on having a brand-spanking new car. In fact, more than 37% of the millionaires that were surveyed purchased a used car most recently, and even if they bought it new, they held onto their car for a good while before trading:

Those purchasing motor vehicles accounted for 81% of the sample of millionaires; those leasing accounted for 19%.