I am being a devil’s advocate here, and just nitpicking on JD of Get Rich Slowly’s endorsement of a Dave Ramsey concept of “Drive Free, Retire Rich“. I will always have the utmost respect for JD and his Get Rich Slowly blog, so please view this post purely in terms of numbers…there is nothing personal against anyone here.
I am not convinced by Ramsey’s “Drive Free” theory. I am sure there are others who are not convinced. If you know something more about this, kindly leave a comment so that we all understand this better.
Ramsey say’s this as a part of his arguments:
You want a brand new sports car that would normally cost you $475 a month. The car you are driving now is worth $1,500.
If you take that $475 and pay yourself instead of paying the dealer, you’ll have $4750 in just ten months. Add that to the $1,500 you can get for your current car, and you can pay cash for a used $6250 car. That’s a major upgrade in car in just 10 months-without owing the bank a dime!
But let’s keep going. If you kept saving at that rate, you’d have another $4750 in another ten months. Chances are, less than a year later, you could sell your $6250 car for about what you paid for it. This means that you can step up again-with-cash-into an excellent $11,000 used car just twenty months from today! Not Bad!
Yeah..not bad…but not feasible either ! Especially, this part: “Chances are, less than a year later, you could sell your $6250 car for about what you paid for it.” Details are given later in this post.
Using this Ramsey theory as the base, JD says:
Hereâ€™s where it gets interesting. If I kept making $250 payments to myself, Iâ€™d have another $3,000 saved at the end of the second year. Letâ€™s say the $6,700 car lost another $1,000 in value and was now worth $5,700. I could trade it in and use my saved money to upgrade to an $8,700 used car.
…I can continue this cycle until I reach the level of car with which Iâ€™m comfortable. After that, the amount I need to save each year would decline sharply….
Taking some of JD’s numbers, let’s run a few calculations for a used Honda Civic and see where JD may land. I am using Honda Civic as an example car, because it’s one of the top “least-depreciating” vehicles. Most other vehicles may give worse results. Given below are two tables. The first table lists prices of used Honda Civics sorted year-wise. The second table gives the difference between the prices of Civics in consecutive years. All values are taken from Edmunds.com.
The above table is indicative of the “market depreciation” of the car. This has nothing to do with how much (or how little) you have driven the car. For example, suppose you buy a 2002 Civic for $10,375…and in the next instant try to trade it in for a better car, you will get only $8123 for this trade in. This means you will lose $2252 on this transaction even without putting any additional miles on the car.
Table 2. Price Difference Between Two Consecutive Years
This table is indicative of the “mechanical depreciation” of the car, that is depreciation due to usage and wear and tear. It assumes a 12,000 miles per year average usage. It is clear from the table that on an average, Honda Civics would lose about $1353 per every year that you use it.
The total depreciation that JD would face if buys a Honda Civic and tries to sell it the next year would be around $3500 and not $1000 as he estimates in his calculations. I am doing these calculations using “trade-in” values, because JD mentions that he would trade it in for a better car. A hypothetical case of JD buying a seven year old 2000 Honda Civic is tabulated below. The table is pretty self-explanatory so I won’t put any efforts on that part.
It is obvious that JD will not be able to buy a similar quality car after the end of one year. To buy a similar quality car (a seven year old car), JD would require to increase his monthly contribution and that would make this a loss making cycle. And btw, all this is with pretty conservative numbers.
What about Ramsey’s numbers?
I ran the same deal for Ramsey’s $475 a month that he uses in his presentation, and the details are tabulated below:
…but there must be a catch. Here, the catch is in the monthly payments itself. If you are ready to save $475 a month for a year and upgrade, then pay another $475 a month and upgrade….you might as well pay that amount a month and get a brand new Honda Civic and just be done with it (no need to drive a junk for 4 years and turn yourself into a annual car salesman trying to buy and sell cars every year). Take good care of the car and it will serve you almost flawlessly for at least 10 years and make the investment worth it.
Overall, I am not convinced about this “Drive Free” theory. But that’s just my opinion. I would be very glad to see someone come up with numbers to support this stuff …or I am going to stay unconvinced.
I have not even considered the cost of repair headaches for used cars….which can sometimes run into thousands. Repairs are required for new cars also, but for used cars they run into a lot more sometimes because you don’t have any idea about how the previous owner used the car.
You can try selling to and buying from private-party (individuals). However, even if you run the numbers for a private-party deal rather than a trade-in, things don’t really add up very well. Also, the moment you start buying/selling cars from individuals, you run the risk of buying a lemon. Not to mention the amount of time you spend in trying to locate a prospective buyer for your old car and a prospective seller for your newer car.
Dave Ramsey mentions in his presentation that average Americans pay 9.6% APR on car loans. I am not sure if that is true…but if it is true..then average Americans are not really getting themselves good deals on car loans. Just a few weeks ago I was involved in a car loan deal for a guy who had a credit score around 670-ish and was approved a loan at 5.99% APR.
I have some more issues, but this post has gotten darn long…so everything else will have to wait