When I graduated university (2006) I was driving a paid for 2001 Sebring, which ran great! However, my co-workers (also recently graduated) went out and got amazing rides – Porsche Boxters, Nissan 350z, Acuras, Corvettes, and even a Lotus Elise. They got the financing from the dealership or the local credit union. A few of them made fun of me for not having the super sports car. Then the Sebring as stolen and totaled - so I got a check from the insurance company.
The insurance gave me the kbb value for the car, and off I went. I fell into the car trap - needing a car to find my identity. I went down to the local credit union and took out a loan for a 2006 Mazda Rx-8, luckily it was used.
However, I had just signed up for a $323 payment every month for the next six years – ouch! After watching my paychecks get zapped by a mortgage, car loan, and insurance payments - I decided enough is enough. Now the RX-8 is gone, and I am driving a used 1996 mini-van. I have my reasons for driving a van over a car at this time. First, I got an amazing deal. It is paid for with cheap insurance. Also, the van is great for hauling drywall and lumber for a home remodel. Furthermore, I think my fiancée secretly loves it, since she says the seats are so comfortable.
On to the story:
After graduating university in 1992, Mr. Eric Engineer landed a great job. In his first year after graduating he was making $78,000 a year. This was very exciting to Eric and his family. Eric had a goal since he entered university, to own a BMW. Eric told his family once he started working that he planned to save money from each pay check for a new BMW (see below).
After saving and working hard with many hours of overtime, Eric had been able to save $65,000 in two years! That Christmas in 1994, he announced to his family that he would take saved money and get a nice new BMW.
After New Year’s Eric went to various auto-dealers in the area hunting for the ideal BMW. Eric test drove a super BMW (740i), priced at around $ 65,000. Eric said “this is it.”
The dealer suggested that Eric should take the car home and show the family. Eric felt like a real success driving in that car. “Look at me now”, he could now say to those who doubted him in the past. He smiled at the thought of getting rid of the rust bucket he drove during university. He was now riding in style.
At home that night, Eric’s father was very happy for son’s achievement. However, his father was bit concerned with Eric’s choice to spend all he had saved on the car.
Eric’s dad was a financial planner, so he suggested to his son that they should sit down and look at other alternatives (e.g. his lost opportunities). Eric had never taken a course in finance, and he was clueless about the power of compound interest.
That night, after running some estimates based on the S & P 500 performance with his father, Eric was convinced now to purchase a nice used car and invest the remaining balance into a mutual fund.
Eric was a bit embarrassed to return that BMW to the dealer the next day, but he knew his financial security was at stake. That month Eric was able to get a good used BMW that still looked nice for around $6000, and was able to invest the remaining money into an index fund that mirrored the performance of the S & P 500. How did this choice pan out for Eric? See below for the results of this $60,000 decision.
BMW (ROI) vs. S&P 500 (ROI)
As we can see, the BWM consistently lost value (15% a year) – no surprise here. While the average return for performance of the S&P 500 was about 10.6% between 1995 and 2010. Eric’s decision of how to spend the $60,000 resulted in a choice between $3000 verse $624,000 in 2010. Eric was very happy with his decision to drive a nice used car.
Sources:
· Motortrend
· MoneyChimp
· Kelly’s Blue Book
Books that have changed my ideas on Money:
Dave Ramsey's Total Money Make Over, which I read in Feb 2011, and it changed my direction. I followed his recommended baby steps and got out of debt! Now I am saving and investing thanks to this book's simple instructions and motivation. Read it!
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