Be aware of putting money into depreciating assets
This week, my two nephews are visiting from Ottawa and we had a conversation about wealth, status and cars.
My younger nephew, Brad, saw a beautiful car on the street and suggested that the man driving that car must have lots of money. My other nephew Matt then wanted to know how old our van was and why we did not drive a newer van. In both cases, Brad and Matt, like most Canadians link status and wealth to the vehicles we drive.
Wealthy people may look different
One thing I have learned from the wealthy people I meet on a day-to-day basis is that wealthy people do not need to show or talk about how much money or wealth they have. In fact, in the book, the Millionaire Next Door by Thomas Stanley and William Danko goes into great lengths to suggest that wealthy people may not look like the stereotypical wealthy person.
The book suggests that wealthy people may not always be the ones driving nice cars, living in the biggest house, or wearing the top designer clothes. Rather, the millionaire next door is the person living in the same bungalow they have lived in for the past 20 years, they may drive a nice car but it is an older well taken care of car with lower mileage.
True wealth lies in your net worth
To really understand wealth, you must understand the concept of your net worth. Simply put, your net worth is what you own less what you owe. The lesson I shared with my nephews is that the car you drive does not always tell you about the wealth of that person. If you go in and buy a $60,000 car but you borrow the entire $60,000, that car contributes nothing to your net worth. So many people these days lease cars only to create more debt and payments as opposed to increase the value of their net worth.
Net worth and depreciating assets
In continuing with my lesson, I created a scenario where the boys bought a car for $60,000 and one year later, that car is only worth $45,000. After two years, the car worth $36,000. And after three years the car is worth less than $30,000. In fact every year they own the car, they lose value. Matt and Brad now understand the concept of a depreciating asset where the value of that asset goes down each and every year.
When it comes to your net worth, it is my belief that depreciating assets should not go onto your net worth statement. Thus, the only way to increase your net worth is to increase how much you have in appreciating assets or to reduce the amount of debt that you have.
At the end of the day, I understand that cars are essential to our everyday lives. However, I believe that cars should be bought more for function and finance instead of for status. I think it is more relevant than ever for people to really look at how much money they can afford to spend on their cars.
For Brad and Matt, I suggested the scenario that makes better financial sense is instead of buying the $60,000 brand new car, it would make better sense to look for a 3 to 5 year old version of that car for $30,000 or less so that someone else loses the bulk of the depreciation. With the extra money you have as a result of not buying the newer car, you can look at paying down debts or investing it into appreciating assets. Once you have saved more money than you need, then you can go buy a new car without having to worry about depreciating assets and how it affects your net worth.
There are tons of good advises out there like this one. I like it. Some wealth manager advice are good too,like from Ed Butowsky.
Being financially savvy is the goal,
Instead of buying a 3 to 5 year old used car with around 30k- 60k miles already on it and a limited used car warranty for $30,000. Why not advise them to obtain a great credit score (720+) and instead of buying, lease a new mid-tier(Honda or Toyota) or lower (Nissan or KIA) or even a entry level high-end (BMW 1series or Mercedes CLA) car for 3years with an accurate mileage rate between 12k-15k and with no money down. The lease monthly payments will be less or about the same of the ($30,000/[email protected]) plus they would have a full manufacture warranty and maybe even 3years free or heavy discounted Maintenance services. If they go with the mid-tier or lesser brand models I’m sure they would have more money(about $160) left over each month to MAX OUT a Roth IRA. Buying a 3 to 5 year old doesn’t mean you are doing the best thing with your paycheck /money. As cars age by years and mileage they end up costing more in REPAIRS and some Maintenance services. The older the car the less of a FULL manufacture’s covered warranty you will have and the higher probability they will have a Car monthly payment of $524 and a REPAIR BILL(example: Oil valve cover leakage repair for $2,000) at the same time. With a new car (3yr lease) you are almost (99%) guaranteed no to be in this situation of having a High REPAIR Bill. Cars are depreciating assets that loses value every year regardless if you drive it or not… The way to play the game and be financially savvy (creating wealth) is to LIMIT the out of pocket expenses on transportation and Maintenance/Repairs and by investing the remainder of money (Maxing out a Roth IRA). Buying an Older Used car would NOT give the owner a peace of mind on the reliability of their car. At some point you will reach the (High cost Repair and/or Maintenance services bill of est. $3k and a car that they will OWN ) be only worth about $2k. Lastly $30,000 is about 6 years of Lease payments @($250 per month)on a Honda Civic(3yrs) and then get a Scion TC(3yrs)with about $9k-$11k invested in a Roth IRA at the same time. Now that’s how you create wealth.