The Simple Financial Trick That Can Save You Thousands

By Markets Fool.com


Photo credit:Helgi HalldrssonSource: Wikimedia Commons

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Buying a new car is almost like a rite of passage. When you feel you've reached a certain level of income, it becomes hard to ignore the siren song of walking into a dealership and knowing you can afford to buy a new car.

However, it's also one of the worst things you can do. Cars are depreciating assets at the best of times, and driving off the lot is a two-minute experience that can cost you thousands of dollars. Here's how it works -- and what to do instead.

New car depreciation: utterly depressing
According to Edmunds.com, the average car depreciates by 11% when you drive it off the lot and 15% to 25% per year thereafter. For a more jarring illustration of what these numbers mean, assume you just bought a $30,000 car and it depreciates at 15% per year:

Moment in time

Value of car

Purchase

$30,000

5 minutes after purchase

$26,700

1 year after purchase

$22,695

2 years after purchase

$19,291

3 years after purchase

$16,397

In other words, after three years the car is worth just over 50% of what you paid for it. Some would argue this doesn't matter if the whole point is to keep the car until it dies, but I would argue it matters a lot. Not only can you get immense warranties for a slightly used car, but the cost savings is completely worth it.

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What the ever-so-slightest downgrade can buy you
What if, instead of spending $3,300 just to drive a car off the lot and another $4,000 for it to be brand new, you buy a 1-year-old car with a reasonable amount of miles on it? Now take that $7,700 and stick it in an investment account growing at an annual average of 6% per year.

Here's what happens:

Moment in time

Value of your investment

Moment of car purchase

$7,700

3 years after purchase

$9,171

5 years after purchase

$10,304

10 years after purchase

$13,790

15 years after purchase

$18,453

20 years after purchase

$24,695

The best part about investing is that, unlike the value of your car, the value of your investment will grow over time rather than decline (barring, of course, financial collapse, mismanagement, etc.). By avoiding the trap of buying a brand new car -- and socking that money away instead of spending it -- you can quite easily earn about $17,000.

Keep in mind that this is at a 6% annual average growth rate, which is a reasonably conservative assumption. At 8% per year the investment would be worth $35,889 in 20 years.

This is the power of spending conservatism combined with compounding growth. It's also the reason why the book The Millionaire Next Door made such a big deal about millionaires not splashing out on fancy cars. Those types of purchases can seem like luxuries-within-reach in the moment, but they cost far more than the initial financial outlay over the long run.

Seventeen thousand dollars for new car smell? No thanks -- I'll just buy the air freshener instead.

The article The Simple Financial Trick That Can Save You Thousands originally appeared on Fool.com.

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