How Often You Buy Cars Matters, Too

Too many people compound their vehicular overspending by trading in their cars for newer models too often. To illustrate how much of a difference it can make to trade in cars less frequently, let's use the example of twins Jordan and Morgan.

Jordan and Morgan each buy their first new car on their 25th birthday. Both borrow $20,000 for the purchase and pay off the loans over five years at 6% interest.

As soon as her car is paid for, Jordan buys another one—a pattern she continues throughout her life, until she buys her last car at age 75. We'll assume that each car is 15% more expensive than the last, reflecting average annual inflation of about 3%.

With those assumptions, Table 7.2 shows that Jordan pays nearly half a million dollars for cars over her lifetime.

Morgan, by contrast, keeps driving her cars for another five years after the loans are paid off. She buys half as many cars over her lifetime as Jordan—and saves an impressive $251,972 (see Table 7.3). Think about that: Just by driving her cars a few years longer, Morgan saves a quarter-million dollars over her lifetime.

And that's just the start of the ways Morgan could be financially way ahead of her sister.

Instead of getting loans to finance her purchases, Morgan could simply save the money that would have gone to monthly payments in the five-year period after she paid off each loan. If she got a decent return on her savings—say, 4% or 5%—and saved a little extra on the side, she could easily pay cash for her next car. If she did that with every car after her first one, she could save another $26,000 or so in interest costs she wouldn't have to pay over her lifetime.

Better yet, let's figure a money-savvy person like Morgan would take those monthly payments and invest them instead.

We'll assume that once she gets her loan paid off, she invests a monthly amount equal to what her sister is paying for a new car. We'll also assume she gets an average annual return of 8%, which is a reasonable estimate for a portfolio that's invested largely in stocks.

Once again, the awesome power of compound returns is apparent: Morgan could have a nest egg worth $2.5 million by the end, as shown in Table 7.4.

Obviously, we're making a lot of assumptions here. The key ones are that Morgan is disciplined enough to invest the money in the years that she doesn't have a car payment and that her investments earn a higher return on average (8%) than the cost of her car loans (6%).

Of course, few things are guaranteed in the world of finance. Conservative investors who don't think they can get better returns on their money might well chose the route of paying cash for their cars, rather than getting a loan and investing their money for a potentially higher return.