READER TIP: Today is Double Post Day! So at the end of this post, click "Next Article" and it will take you to the second blog post of the day. Enjoy!
Once again, thank you for all of the positive encouragement surrounding these posts. I have a long list of recommendations already and I’m excited to jump into something I know is applicable to 99% of us: Cars
First off, a little recap of investing and how that works. You save money, you buy investments, and over time those invests go up in value and pay you interest/dividends. It’s really that simple. The only reason you would lose money is
1) you sold at the bottom of a big drop (that is when you should be buying and getting these high quality investments at an even lower price)
2) piggy backs off of #1, you needed the money and we’re forced to sell at an inopportune time
Other than those two reasons, you should be investing at least 30% of every paycheck, which includes your 401k and IRA contributions, and watching the balance grow over time. Visit my last article for a guide on how to get started investing if you haven’t already. If you make money, you have no excuse. Remember, the average annual performance of the stock market over hundreds of years has been ~7% after accounting for inflation and taxes. Use this to your advantage, just like the Millionaires in Tom Stanley's best selling book, The Millionaire Next Door: The Surprising Secrets of America's Wealthy.
If you do the math, $100,000 invested at 7% for 2 years would be $114,490 ((100,000 * 1.07)*1.07). See how that number isn’t 114,000 even? That’s because in the second year, your return of 7% is calculated on the $107,000 that your account would be worth after the first year. This magical phenomenon is called compound interest (where your previously earned interest makes you more interest) and literally will change your life.
One other point on that: Humans are TERRIBLE at estimating compound growth. For example, try to estimate how much the aforementioned 100 grand would grow to if it compounded at 7% annually for 50 years instead of just 2 years. You probably didn’t think it would reach almost three million dollars. Remember:
When you’re investing, this year and next year don’t matter much. It is the long term patience and time in the market that will pay you the most. Einstein once said that compound interest is the eighth wonder of the world; Those who understand it collect it, and those who don’t understand it pay it. (In the form of interest on loans, credit cards, etc.)
With the math in mind, it is easy to see how a seemingly normal expense like a car payment (US Average of $499/mo before insurance, gas, tolls etc.) can add up to literally millions of dollars over the course of your life. Even if you have a “cheap” car (say, $200/mo) it is costing you the ability to invest that money. In economics, we call this the “opportunity cost” because it is costing you an opportunity. Economists are not necessarily known for their creativity.
So the opportunity cost that you are giving up by choosing a $200 car payment is having $1,000,000 in 50 years. JUST FROM ONE CAR PAYMENT, add in the affiliated expenses or a more expensive car and you can calculate how ludicrous the numbers get. Use this compound interest calculator to help you. When using the calculator:
Current Principle: $0
Annual Additions: (Car Payment)*12
Years to Grow: 50
Interest Rate: 7%
Total Balance After 50 Years: $1,043,966
If you calculate that your car is costing you $500 total each month (about the average), you are losing the opportunity cost to have $2.5+ million dollars in 50 years. After explaining how this math works, the light bulb goes off for most people and they realize how ridiculously expensive having a car on monthly payments is.
The MOST cost effective way to have a car is to buy a used vehicle outright. Some great deals can be had on a car that is 2-3 years old with low mileage because somebody else leased it and already paid for the depreciation. Cars usually depreciate most in the first 3 years, so whoever leased it first paid for all of the depreciation for you. Thanks generous stranger! Although I am 99% positive they thought they were getting a “steal” when the sharky looking guy at the dealer offered them a low monthly payment of $499/mo (before taxes, fees, plates) on their shiny BMW.
You shouldn't have a monthly car payment, so when you’re looking to buy your used car make sure it is something you can afford. This allows us to get a low cost insurance plan because we don’t owe anyone any money on the vehicle. Combine this with a close proximity to work and maybe a bicycle for getting around closer distances, and I’m sure that most people can get from paying $499+/mo to less than $200 including all expenses. It would be unrealistic to think that we can cut all of our car related expenses out, but minimizing them this way is the best most of us can do. And now you can calculate how much you’re saving yourself! Woo!
I hope that this insight into opportunity cost and how seemingly harmless decisions effect your financial future will make you a more conscious spender when it comes to all of your monthly expenses, not just your car!
If you thought this was helpful, terrible, or somewhere in the middle, please leave me feedback in the form of a Direct Message on instagram @nico_pasq, or feel free to send me an e-mail/text to the information on my Home Page. I truly appreciate constructive criticism and opposing views, so bring em on!
P.S. New blog posts coming your way every Monday!
I love books, so it is probably a natural progression that I have come to LOVE AUDIOBOOKS! Here is a link to a 30-day free trial to Audible, along with TWO free audiobooks of your choice. Don't like the service? No problem, they will let you cancel and you'll even get to keep the books you chose to try. Enjoy!