Monday, February 25, 2008

Savings on cars is a great investment vehicle

In Fidelity Investment's quarterly magazine this month, they had an article entitled Rev up Your Retirement Savings. In this article, they declared that the average car loan is $479/mo and lasts 48 months based on information they had gotten from Edmunds. If people kept their car an extra year and invested that $479/mo with a 7% annual return, they would have $199,190 in 35 years. If they kept it two extra years, they would have $331,823 in 35 years. I set out to look closer at these numbers...

First, the data for their average expense of a vehicle comes from this article at called ABCs for a great car loan. That article says:

In the United States, the average down payment for a car is $2,400, the average amount financed is $24,864 and the average monthly payment is $479, according to The most popular loan term is now a payment-stretching six years. If you're "upside down" on your old car loan (you still owe money on it after the trade-in), it's no longer a deal breaker. In these days of easy credit, lenders will roll the old balance into the new. Nor are down payments de rigueur; you can finance up to 100% of the manufacturer's suggested retail price, plus taxes, tags and fees.

So, according to that the average car costs $27,264...but is 6 years and not the 4 years Fidelity uses. So, they already have a hole in their logic. Regardless, I think $27,264 is a bit high and I will use their numbers, $479 for 4 years making the total spent on the car $23,000 including interest.

By my calculations, at 4.8% this $479 payment for 48 months would let you buy $20,485 worth of a car. If I take that as your initial savings when you have a car loan and as not your initial savings when you don't have a car loan, than I can run some different numbers. SO, if you had $20,485 and got this 4 year loan at 4.8% interest but in the fifth year put all $479/mo ($5,748) towards your savings and got a 7% return, then you roughly would have $342,500 after 35 years. If you keep the car an extra year and put another $5,748 towards your savings with 7% return, you would have $430,500 roughly. If you paid off the car with your initial savings and bought a new car every 5 years, saving the rest, you would have $228,200 at the end of 35 years. That initial lump sum grows more quickly with compound interest than you can keep up. With buying a new car every 6 years debt free, you end up with $322,600 and every 7 years you end up with $390,000. All of this can be seen on the chart above.

Does this mean going debt free does not make sense when you run the numbers? Absolutely not. Because what is not shown, is the risk. Would you take a loan out at 4.8% per year to put it in mutual funds? Probably not...but thats essentially what you are doing. Because I had the spreadsheet made, I was able to play around in numerous what if sort of scenarios. What if interest rates on car loans go up or what if we hit a bad point in the economy where stocks go flat? That can't happen, could it? Of course it could and it is happening right now. In these cases, the no debt models win every time.

Feel free to email me if you want the spreadsheet to play around for it yourself...

No comments: