How a $40,000 Car Can Cost You Millions of Dollars

An important part of building wealth is controlling your spending, but this is sometimes easier said than done. We have all had the experience of buying things that we probably shouldn’t have purchased. We have a moment of weakness, make the purchase, and then feel guilty about it. Sometimes keeping our spending low is like going on a diet. We do it for a while but have trouble maintaining it. What can we do to help us stop ourselves from taking actions that we know we shouldn’t take?

Change Your Thinking to Change Your Behavior

If you are doing something – anything – that you wish you wouldn’t do, then be aware that it is because of the way you think. If you can change the way you think, then you will change the way you behave. When you successfully avoid fattening foods, you are thinking differently than when you succumb and eat the fattening foods. When you talk yourself out of buying the latest electronic gadget, you are thinking differently than when you impulsively make the purchase. Both the things that you focus on and the things that you do not focus on are different. The key, then, is to think differently.

Consider the Ultimate Cost of Your Purchase

One trick that I have begun to use over the last few years that has helped me control my spending is to consider the ultimate cost of making a purchase. The cost of buying that new high-definition flat screen TV isn’t just the $2,500 purchase price. It isn’t just the electricity to run the TV. It isn’t just the new entertainment center to hold your new TV. In fact, these represent just a small fraction of the ultimate cost of that new TV. By far the greatest cost in purchasing the TV is what you gave up to purchase the TV. When you plunked down that $2,500 to purchase the TV, you gave up $2,500 that could have been invested and turned into considerably more money down the road. You are trading your future wealth for the TV.

By now you might have figured out how a $40,000 car can cost you millions of dollars. By buying that $40,000 car, you are giving up the opportunity to turn that $40,000 into millions of dollars. To better understand what I’m talking about, look at the following table that shows how much your spending ultimately costs you assuming that you could have instead invested the money at a 10% rate of return (the long-run stock market average rate of return).

Years	$1	$2,500	$40,000
5	1.61	4,026	64,420
10	2.59	6,484	103,750
15	4.18	10,443	167,090
20	6.73	16,819	269,100
25	10.83	27,087	433,388
30	17.45	43,624	697,976
35	28.10	70,256	1,124,097
40	45.26	113,148	1,810,370
45	72.89	182,226	2,915,619
50	117.39	293,477	4,695,634

By considering the ultimate cost of that new TV or new car, you become acutely aware of what it will cost you in the long run. Within 35 years, that $40,000 car would cost you over $1 million. It doesn’t matter if you only have the car for 10 years. The original $40,000 cost will continue to compound for the rest of your life. After 35 years, that car will have cost you over $100,000 per year to just cover the purchase price! I don’t know about you, but right now I can’t afford a car that will cost me over $1 million! Even over 20 years, it would cost over a quarter of a million dollars.

This doesn’t even include the ultimate cost of higher insurance premiums. If my insurance is higher by $1,000 annually for 20 years, then the additional insurance will cost me about $63,000 over 20 years (calculated by adding $1,000 compounded for 20 years plus $1,000 compounded for 19 years plus $1,000 compounded for 18 years and so on). Over 35 years, we are talking about an additional cost of almost $300,000!

Here is another example. Let’s say you are trying to decide whether to upgrade your cable TV package with a movie channel that costs an additional $10 per month. At first glance, $10 per month might not seem like a lot of money, but by compounding the $10 additional monthly cost over 240 months (i.e. 20 years), you would find out that the movie channel would cost you about $7,700 in 20 years. And this assumes that the cost of the movie channel doesn’t increase at all. What is the chance of that? If you extend the period to 420 months (or 35 years), the cost goes up to $38,300. Is it worth it? This is a personal choice that will obviously depend on your values and your current financial situation. If you absolutely love movies and you are doing well financially, then it might be worth it.

To get an idea of the ultimate cost of your spending, you can use the table above. Use the column for the $1 dollar cost and multiply it by the cost of the purchase you are contemplating. For example, a $10,000 purchase will cost you approximately $67,300 ($10,000 X 6.73) in 20 years since every dollar of spending ultimately costs $6.73 in 20 years.

Calculating the Ultimate Cost of Spending

[GEEK ALERT! If you aren’t really interested in the mathematics behind it or if mathematics isn’t your strong suit, you can skip to the conclusion].

The calculations of the ultimate cost are based on the mathematics of compounding. I described the amazing power of compounding in my post Start Now! Don’t Let Procrastination Cost You a Fortune! Here is how it works.

The formula for calculating the ultimate cost is as follows:

Ultimate Cost = Initial Cost X (1 + Periodic Rate of Return)^Periods

[Note: The “^” symbol is the symbol for raising a number to a power].

For example, the $1 cost in 20 years equals:

Ultimate Cost = $1 X (1 + 10%)^20 = $1 X 1.10^20

Ultimate Cost = $1 X 6.73 = $6.73

The ultimate cost of a single $10 monthly payment in 20 years (i.e. compounded over 240 months) would be:

Ultimate Cost = $10 X (1 + 10%/12)^(20 X 12)

Ultimate Cost = $10 X 1.0083^240 = $10 X 7.27 = $72.70

With a spreadsheet, you can calculate the cost of all of the 240 monthly payments over 20 years by repeating this calculation using 239 months, then 238 months, and so on until the last calculation with 1 month. Add all these monthly calculations together to get the total cost of the $10 monthly payments (about $7,657). You could also approximate the cost by compounding $120 annually over 20 years instead of $10 monthly over 240 months (about $7,560). As you can see, the cost will be slightly underestimated using annual compounding, but it is close enough.

Conclusion

By thinking about the ultimate cost of a purchase, you will be able to make better spending decisions. My goal isn’t to try to convince you that all spending is bad. My goal is to help you put your spending decisions in context and to illuminate the tradeoffs that you are making and might not be aware of. For example, let’s say that instead of buying a $40,000 car, you buy a car that costs only $20,000. The ultimate cost of the $20,000 car in 20 years would be about $135,000 less than the $40,000 car (the $20,000 savings X 6.73 = $134,600). Maybe this $135,000 would allow you to retire 2 years earlier just from buying the cheaper car. On the one hand, it would be nice to have the $40,000 car, but wouldn’t it be nice not to have to go to work for 2 years? By thinking about the ultimate cost of the purchase, you will be better able to weigh the tradeoff according to your values.

In my own life, people often ask me why I still drive a 1989 Jeep Cherokee. They tell me that I should buy a new car. I would love to buy a new car, and I probably will buy a new car eventually. However, for the time being, I prefer to accumulate capital and save towards financial freedom. When I weigh the tradeoff between a new car and financial freedom, financial freedom wins hands down. The idea of being freed from the necessity of work is very enticing to me.

So before you make that purchase, ask yourself:

Is the tradeoff worth it to me?