By Barefoot Investor Scott Pape.
Free cars buying plan
Most people know that I’m not a car guy, especially when I arrive at an investment meeting in my ute. Yet like any good advisor I never let my prejudices affect my financial advice.
Last week I met up with a young couple that were hell bent on buying a brand spanking new Commodore – and I set them up on a plan that will eventually provide them with free cars for life.
That’s no misprint. (And no, it won’t be ‘free Kia Rios for life’). The plan I put in place will have them consistently driving late model Commodores.
Here’s what happened.
The Toxic New Car Smell
The couple I met was referred to me by one of my old clients who pleaded with me to ‘talk some sense into them’. Rick and Samantha were in their early 30s, had been married a few years, and were frustrated that they still hadn’t been able to crack into the property market. To compensate they had fixed their thoughts on buying the status symbol of choice, a new car.
I could tell that they’d already been looking at cars – they had learned to parrot back the sales-speak perfectly:
‘We’ll be having a family soon and we need a good car. It makes sense that we don’t buy someone else’s problems. And you get a new car warranty”.
For reasons I still can’t quite comprehend, they set their sights on a brand new 2010 Commodore, and the dealer had scribbled $39,990 on his business card. They told me they were planning on getting a new car loan from their bank.
I pulled out a piece of paper and explained the following: If they took out a five-year car loan with an interest rate of 11.25 per cent, they’d have repayments of $875 a month.
A $40,000 Loss
Five years later they would have paid back the $40,000 loan – along with an extra $12,478 to the bank in interest. If they choose to borrow and buy the Commodore they’ll spend $52,000 of their hard earned – all so they can own a car that is worth about $10,000 (according to car industry source Red Book)! That’s what you call wealth destruction.
Worse, if they’re anything like most new car buyers, they’ll soon get another whiff of the new car cologne and repeat the process – and probably be broke for the best part of their lives because of it.
As a money guy, helping people avoid these disasters is like running down the centre of the footy ground and booting the match-winning goal, fist pumping the air…only to end up hitting the post:
Bloke: “Yeah, but, we need a nice car…And I reckon we can afford it”.
Barefoot: “We are talking about a Commodore, aren’t we?”
The conversation between the three of us was like a blind date when you walk in, see the person and want to walk straight back out of the room, but don’t, just to be polite. They’d already made up their minds.
That was until I pulled out a strategy that I call ‘free cars for life’, that I learned last time I was in the land of the never-ending car payment from an anti-debt campaigner called Dave Ramsey.
I asked the couple what car they currently drove, which Jeremy Clarkson reincarnate confessed sheepishly was a ‘limited edition’ Nissan Pulsar – a clunker of a car:
Legend has it that in the late eighties at a boozy Tokyo lunch a sloshed Nissan executive decided it would be a great idea to join forces with Reebok and manufacture a Reebok branded Nissan Pulsar – which consisted of a Reebok sticker on the bonnet, and an FM-sports radio.
The car held its value like a sweaty pair of sandshoes, which the couple assured me would be lucky to fetch $1500.
Here’s the plan I gave them:
Instead of buying the brand new Commodore, I advised that they tighten up their laces and hold on to the Reebok for another ten months.
Now rather than paying the bank a repayment, I suggested they put the equivalent amount of money – $875 each month – into a high interest online savings account.
After ten months they’ve saved up $8750.
They could then sell the Reebok Rocket for $1500, which gives them $10,000 to buy a 2005 Holden Commodore – for cash.
Just six months later, they’re still making those monthly repayments – although to their own savings account, not to the bank – and they’ve now managed to save another $5,250 in the kitty.
They could then sell the 2005 Commodore (which they get roughly the same money for), and combined with their savings, would be able to buy a 2009 Commodore for $15,000 – not exactly what they wanted, but I assured them that on hot days when the air conditioner is on, it would still occasionally let out a bit of that new car smell.
Let's say they decided to keep making their $875 monthly car repayments, but instead of depositing it into a savings account they now invest in a low-cost managed share fund that invests in solid, dividend paying Aussie companies.
A $40,000 Profit
At the end of five years, they’ll be in the same situation that they would be if they’d bought the 2010 Commodore – they’d own the car outright.
Yet instead of losing $40,000 of their hard earned by borrowing from the bank and buying the brand new car – with this strategy they would instead have about $40,000 in their managed share fund!
That’s what you call wealth construction. But it gets better.
Free Cars For Life
The couple decides it’s time to upgrade and sell their (now six year old) 2009 Commodore and replace it with a nice, reliable fairly new $15,000 car. Which still leaves them with $25,000 in their managed share fund.
The kicker is that even if they never put in another cent – never make another car repayment – every five years or so through the miracle of compound interest (minus a little tax, but factoring in the trade in), they’ll have enough money to replace their car with another solid, reliable $15,000 car, for the rest of their life!
I’ve long understood that I’m unique – most people prefer to drive cars that need to be locked. Cars are never a good investment, but with some savvy money management that new car smell doesn’t have to knock you out.