Nathan and his family pulled into our driveway in a grey 2006 Honda Accord. Each summer, he drives about 7 hours from his home in upstate New York to where my wife and I stay on Long Beach Island, New Jersey. It was the first time I had seen this car, which he had purchased two weeks before.
My friend is particular. When he comes to visit, he brings his own water. He brings his own organic eggs and milk. The 46 year old looks like he was chiseled out of granite. Nathan works out daily in his home built gym. He’s a master of efficiency, whether it’s physical, nutritional or financial.
Nathan, his wife, Stacie, and their daughter brought their luggage into our house. Nathan saw that my laptop was open. I was putting together a presentation on saving and investing for a conference in Orlando. I had been running some numbers on a common question: Is it better to lease a car or buy one?
Most people say that buying a car costs a lot less than leasing. Nathan takes that to a whole new level. “Leasing cars,” he said, “is a $1 million dollar decision.”
I thought he was crazy–until we did the math.
Nathan’s car cost him $5,500. He has never paid more than $6000 for a car. Nathan looks for cars with low mileage. The average American drives 12,000 miles a year. That means the typical 10-year old car would have about 120,000 miles on it. Such cars may nickel and dime their owners as the cost of maintenance creep up.
But the car that Nathan bought had just 60,000 miles on it. It has as much wear and tear as the average five-year old car. “A well maintained car with 60,000 miles on it still has plenty of life left,” says Nathan.
He typically drives his cars for 3-5 years. Then he sells them for a price that’s not much lower than what he paid. “I should be able to get at least $3,500 for this Honda,” he says, “if I sell it in 3-5 years.”
But how could leasing cars cost a million dollars?
Nathan considers the opportunity cost. That’s the financial cost between making one decision over another. Finance writer, David Bach, popularized the idea with his Latte Factor analogy. He said that if people drank coffee at home, instead of enjoying their daily Java at a popular coffee shop, the savings (if invested) could grow to a million dollars.
Critics say that Bach’s calculations overestimated the cost of coffee. They say that he calculated unrealistic investment returns. But such critics miss the point. Bach was simply showing how small sums of money, if invested regularly, grow large over time.
Still, many people prefer to lease new cars. I can see why. When business owners file taxes, they can declare car lease payments as expenses. That lessens the leasing bite. Soccer moms can get into a minivan that costs less, per month, than if they made monthly purchase payments on a new vehicle.
Finance author, Dave Ramsey, is no fan of leasing. He says, “Broke people think ‘how much down and how much a month’. Rich people think ‘how much’. If you can’t pay cash for a car, then ride a bicycle. But don’t lease a car.”
The late Thomas Stanley, in his book, The Millionaire Next Door, said that 80 percent of millionaires have never leased a car. My friend, Nathan, is one of those millionaires.
Like many wealthy people, Nathan and Stacie track their spending. “Over a five year period,” says Nathan, “a typical car of ours will cost us $9,000. That includes the car purchase and total maintenance. We always pay cash.”
After 5 years, they usually sell the car and buy another.
According to Edmunds.com, the average midsized leased car costs $294 a month, or $3,528 a year. But most households have two cars. That means leasing two cars costs the typical household about $7,056 per year. Leasers could end up spending more if they exceed mileage limitations. Most dealers set a limit of 12,000 miles a year.
Nathan and Stacie’s two cars cost them about $2,200 a year, after calculating purchase price, maintenance costs and resale value. The difference between buying low cost, low mileage used models versus leasing, is about $4,856 a year.
That’s almost a fully-funded IRA.
Vanguard’s S&P 500 index fund averaged a compound annual return of 9.2 percent from January 1990 until July 2016. If a couple invested $4,856 a year, and if they earned such a return, it would reveal the eye-watering opportunity cost of leasing two cars.
Over 15 years, it could cost $158,162. Over 35 years, it could cost more than $1 million dollars. That’s why my friend says that leasing cars is a $1 million decision.
It’s easy to come up with reasons why this wouldn’t work. Perhaps your investments wouldn’t gain 9.2 percent. Perhaps you couldn’t find well maintained, low mileage used cars. Perhaps your used vehicle maintenance costs would exceed an average of $3000 every five years.
You might pay more than what Nathan pays for a good used car. But a lifetime of buying used over leasing should still easily win–to the tune of a few hundred thousand dollars.
Benefits Of Buying Used Over Leasing
(Based On 2 Cars Per Household)
|Used Cars||Leased Cars|
|*Assuming $4,856 invested annually at 9.2 percent per year|
Cost Breakdown Comparison
|Max Purchase Price Per Car||$6000||$0|
|5 Year Maintenance Costs Per Car||$3000||$17,640 (lease payments at $294 per month over 5 years)|
|Total Spent Per Car||$9000||$17,640|
|Resale Value Per Car (5 Years Later)||$3,500||$0 (sometimes it costs money to turn in a leased car if there’s high wear and tear or if it exceeds mileage limitations)|
|Cost Per Car After Resale||$5,500||$17,640|
|x 2 Cars||$11,000||$35,280|
|Savings Per Year||$4,856||$0|