Approximately 58% of American adults under the age of 35 will purchase a car that has a negotiated price of $40,000 or greater. This is hardly a surprise, as the Kelly Blue Book has indicated that the average price of a new car crossed the $33,500 last year. The purchase of a new vehicle is something that takes a huge toll on wealth accumulation.
This is because people tend to focus on whether they can handle the monthly car payment rather than analyze the cumulative cost of those car payments to figure out the true cost (which includes interest payments for purchasing the car). With average interest rates for those with credit above 630 is 4.5% for car loans, those monthly $400+ payments are going to cost just shy of $10,000 in interest tacked onto the cost of a car.
If your credit rating is lower and you have to borrow at 7.5%? Then you’re looking at almost $18,000 in interest payments over a ten-year term. Those kinds of obligations, which I suspect car buyers agree to without fully thinking it through, could otherwise provide the seed capital for getting ahead. The opportunity cost for every expenditure that you make when you’re young is high because each dollar could have a heck of a long time period to achieve growth.
Those $18,000 in interest payments on a $40,000 car for a low-credit quality borrower? That literally could grow into a million-dollar fortune if that money were invested in U.S. stocks that delivered the same returns as the Dow Jones during the 20th century and held for 40 years.
This mathematical reality was on my mind as I read through Dr. Thomas Stanley’s excellent work “The Millionaire Next Door” in which he discussed the two characteristics that were most common among self-made millionaires: (1) 82 out of every 100 millionaires haven’t gotten divorced; and (2) 77 out of every 100 millionaires drive cars that are in the bottom quartile of what their peers that earn commensurate salaries purchase.
Almost by definition, this correlation is causation. If you are spending $150 per month in interest payments alone, and you do that throughout adulthood, you are forgoing $972,000 if the alternative is common stock investments that earn 20th century U.S. historical rates. That is just one minor, seemingly almost trivial expense that turns out to be an enormous cost over the course of a lifetime.
Because everything is so darn fact specific, it can be difficult to draw up hard-and-fast rules. But I would say this: If your salary is not in the six figures, you shouldn’t be driving a car that costs more than $10,000. My calculations above only spoke to the effect of interest rates. If you buy a $10,000 car instead of a $30,000 car, that extra $20,000 could turn into almost $2 million under the assumptions laid out above.
With every car purchase you make, you have to decide: Would I be willing to purchase a little less flash so that I can build my family’s treasury or would I rather go to work to enrich the shareholders of auto manufacturers and the big banks that provide the financing? People don’t pose this question because an estimated 80% of Americans lack financial literacy and the attention goes to whether the monthly payment is affordable compared to your salary without regarding for the true cost. I would imaginable that Americans would find themselves getting ahead financially much easier if they focused on purchasing the lowest cost car that wouldn’t carry a likelihood of regular repairs and invested the difference into blue-chip stocks.