Thursday, July 19, 2012

Late Model Used Cars

Saving 1/3 on the cost of anything is a good deal.

Most financial gurus and money talk pages state that the best car value is a late-model used car, that you buy secondhand and keep for about a decade or so.   Why do they advise this?  Are they just making shit up?  Of course not.   The reality is, this is the best car value for most folks, in terms of overall driving costs, depreciation, repair costs, insurance, and the like - while providing the best level of reliability for the dollar spent.

Buying brand-new cars every few years is horrendously costly, and the reliability factor is often less, as the car has to be taken in for one warranty repair after another.  Similarly, fishing too far downstream and buying clapped-out junkers, can be far more expensive than buying a reasonably used late-model used car.  There is a happy medium here - a "sweet spot" in the Depreciation and Weibull curves, where cost is low and reliability is highest.

Depreciation Curve:   A lot of people like to talk about "depreciation" without knowing what it means.  This is understandable, as the term has a lot of meanings, in finance and tax law, as I have touched upon before.  You can "depreciate" a building on your taxes, even though it is appreciating in value.  It makes no sense.

But in terms of car ownership, depreciation is easy to understand.  It is the difference in price between what you paid for the vehicle, and what you sell it for, down the road.  And this usually is the single largest expense in owning any vehicle, with insurance usually coming in second, for newer cars.

The problem is, all cars depreciate horribly over time, and there are very, very few exceptions.   Car salesmen will say "Well, these cars don't depreciate much!" in order to sell you a car.  But when they say "much" they really mean "very slightly less than average."

Even cars that "don't depreciate much" such as Japanese cars or BMWs, tend to hemorrhage in value over time.   My BMW X5 retailed for $53,000 new and probably went out the door for a little under fifty grand.  I bought it four years later for $25,000, or about half the purchase price, new.  This is not atypical, but predictable.

The first few years of ownership are the most expensive, in terms of depreciation, simply because the initial purchase price is so high.  On average, most cars depreciate about fifty percent every five years.  And this is a good rule of thumb to use - whatever the make and model, chances are, they will fall in around these values.   Very, very few cars, even "special models" or exotics, defy these rules - or defy them by much.

So the idea that you will defy the depreciation curve by purchasing a limited-edition Corvette is, well, bullshit, basically.  And if you believe this, chances are, it is because a salesman or someone else hyping the car said so.

New Car Depreciation:  The biggest bit of depreciation, however, occurs in the first ten minutes you own the car.   A new car, once titled, is worth 5-10% less than a new one.  It makes no sense at all, of course.   It is the same car, but it might have been driven ten feet.  But since it is "used" it is worth less. 

Why is this?

Well, there are several things at work here.  First, the value of a car on the used car market, ten minutes after the sale actually represents the market value of the vehicle.  The price you pay for the car, brand-new, is inflated over the real market value.  It is as simple as that - new-car dealers charge more for cars than they are really worth.

There is also a psychological factor at work here as well.   People perceive things that are "used" to be worth less, and thus pay less for them.   And in personal finances, oftentimes this perception works to your advantage.  

There is also the secondary psychological benefit of "buying new" that many people enjoy - the process of shopping, being waited upon, of driving home with a price sticker on the windshield (or carrying home a purchase in a bag from an upscale store) and the perception of having choice and selection (often merely a perception these days, as "custom ordering" cars is very rare, and with option packages, there are few truly custom-order cars anymore).

Of course, for most consumer goods, this drop-off is even more precipitous.  If someone offers to sell you their flat-screen television, ten minutes after they bought it, you would likely pay a lot less for it, as you cannot return it, if it is defective, and moreover, the warranty may not apply to you.  For cars, of course, warranties are now transferable to subsequent owners, so this is less of an issue.

But the other side of the coin is the market force - the seller has something he wants to get rid of, and there are few buyers.   If you want to sell your flat-screen television, ten minutes after you bought it, well, marketing it and finding buyers is difficult.   For a car, the same effect applies.  If you take the car back to the dealer, they will offer you less than you paid for it, as they have to sell it now as a used car, and make a profit in the transaction.  The best you will get is a "high" trade-in value.

The secondary market realizes this, and knows that your only other option is to trade-in.  And not surprisingly, most "Private Party Sales" prices in the pricing guides are at or slightly above, trade-in prices.

For whatever the reason, a new car is worth a lot less when slightly used, and this represents a real bargain, compared to a new car.

Let's look at some real-world examples, based on cars I have bought over the years, and how that buying brand-new cars is staggeringly more expensive than buying a slightly used car.

Example #1:   I bought a 1995 Ford F-150 Supercab XLT Lariat 4x4, brand new, off the dealer lot.  It retailed for over $25,000 and I paid about $22,000 for it, through a pricing club.   I saw the same truck, in a different color, for sale, used, with 25,000 miles on the clock, for $17,000 - a $5,000 difference in price.

I kept the truck for 15 years, drove it 130,000 miles, and sold it for $4,000 on eBay.  If I had bought the used truck, the additional 25,000 miles would have hardly made a difference over the 15-year term I owned the truck, in terms of durability and resale value.  The net savings would have been $5000 plus the interest on the car loan I took out at the time, PLUS the reduced insurance costs and reduced property taxes in Virginia (about $1000 the first year alone!).

Easily, I could have saved $7,000 or more by buying used, and the only downside is that I would not have had the color I wanted (big deal).  This is nearly one-third savings over the price of the new truck!

Example #2:  I bought a 1995 Ford Taurus SHO, brand new, off the dealer lot.  It seickered for $32,000 and I paid $25,000 for the car.   Again, I found one about year old with 25,000 miles, from a private owner, for about $19,000.  If I had bought that car, I would have saved $6,000 right off the bat, and the overall durability and resale value after five years would not have been affected much (mileage affects resale value by only a few hundred dollars at that point).

I could have easily saved close to $10,000 by buying used - more than 1/3 the price!   But more to the point, I could have saved $25,000 or more by simply keeping my seven-year-old Camry another five years.  Sometimes the best used car value is parked in your driveway.
Buying brand-new cars never "makes sense" in that you are always paying a lot more for the privilege.  And any argument you make to the contrary is just self-justifying poor financial planning.   Fortunately, there are a lot of people out there who are foolish with money, and they will "trade up" every few years.  Taking advantage of people who are foolish with money is the easiest way to get rich in America.  I suggest you do it.

When to Unload?    So, it is clear, that buying a late-model used car is a heck of  a bargain compared to buying brand-new.  If the car was well taken care of, chances are, it will go as far as a new car, and is likely still under warranty when you buy it.  You do have to seek out a car owned by an individual owner, not some "mystery" car on a used-car lot.  And you have to find a car that was well taken-care of and has all the service records.  And you have to pay to have it inspected by a competent mechanic before buying it.  Hard to do?  Maybe. Not as hard as trying to get a "deal" on a new car.  And most good things in life do require effort on your part.

 But when to unload?  That is the key question.  The "Sweet spot" of car ownership is that period from just after new to just before it needs a lot of work.   And the depreciation curve can be very instructive in this regard.  The market values of a used car are often the wiki interpretation of millions of people as to how much more reliable life a car has left in it.

Again, I am assuming that you are not like me, and do not have a garage full of tools and access to cheap parts, and the skills to do your own repairs.  If you can fix your own car, it adjusts the analysis somewhat (but not entirely) in that you can "keep alive" an older car for longer - at a reasonable price.  But even then, every car has an end-point, even for the shade-tree mechanic.

But, eventually, one tires of owning a car that, as one person told me, "requires my constant intervention."   And a good test is, would you loan this car to your spouse or friend, without worrying about them breaking down somewhere?   Would you have to show them how to jiggle the key, or some other "trick" to keeping the car going?  If so, perhaps it is time to move on in life.

It is hard to say when to unload a car.  In the 1960's and 1970's, few cars went beyond 100,000 miles, and in fact, selling before the 50,000 or 80,000 mile mark was usually considered a "smart" move by many folks back then.  Since people drove less back then, that might be five to eight years of driving.

Today, we drive more, and cars are better made.  So perhaps 200,000 miles is the new 100,000 miles.   After 10 years, the average car can expect to have about 150,000 miles on it.  And for many people, this is probably a good time to think about where this is heading.

At that point, you may be able to get some money for the car.  For example, a car that cost $20,000, after ten years, may be worth $5,000, which represents 1/4 of its purchase cost.   Keeping the car another five years means it will be worth $2,500, if that.  But the repair costs can skyrocket over those next five years.

Repair Costs:  What can go wrong?  Well, in the first decade of ownership, only basic maintenance is really necessary.  Oil and other fluid/filter changes, brake jobs, and tires are the only real major expenses, along with things like serpentine belts and tensioners and timing belts (if applicable).  Anything other than this is really not an "expected" repair cost for the first decade of ownership - these days.

After that point, however, your car may need a lot of expensive things to keep going, some scheduled, some unexpected, but predictable.  For example, oxygen sensors on most cars made today are slated to be replaced at about 100,000 miles - and many cars made after 1995 have two or four of these, at $200 apiece plus labor.   And other sensors, such as ABS, Mass-Air-Flow, camshaft position, crankshaft position, and the like, may go South.  Often they are either cheap parts that are hard to replace, or expensive parts that are easy to replace.

Throw in things like secondary air pumps (emissions), fuel pumps and filters, and, well, it can get expensive, in a hurry.

But even more simple mechanical things may start to fail.  If you did not flush your brake fluid regularly, you may be looking at a master cylinder, calipers, or even brake hoses (which crack and fail over time).

Suspension components wear out.  Rear shocks are easy to replace, but front struts can be expensive to buy and expensive to install.   And tie rod ends, ball joints, and even suspension bushings wear out, over time.   You can let these things go, but it often isn't safe, or will result in quirky handling or an uncomfortable ride.  A suspension overhaul can cost a few thousand dollars, unless you can do the labor yourself - even then the parts cost can be in the thousands.

And then there is rust.  Most cars today don't suffer from body rust - very often.  But underneath, salt and corrosion take their toll, and making fixing a car a nightmare.  Rusty brake calipers seize up, and their attachment bolts snap off.  Brake bleeder screws weld themselves to the caliper, and the brake lines and hose fittings literally rust off (BTDT!).    If  you own a car in "salt country" there is an additional incentive to unload at about the decade mark.

Compounding Costs, Cascading Events, Repairing Repairs, Waddington Effect:  So when do you call it quits?  There is no hard-and-fast rule, to be sure.  But what usually ends up happening is that a person throws money at a car - usually a few thousand - convinced it is "cheaper than a new car" and then a few months later, discover they need to spend a few thousand more.

At that point, they have "invested" more money in a clapped-out car than they would have spent on a newer, lower-mileage car.  And the resulting car is not viewed as reliable, comfortable, presentable, or even functional.

For some folks, the car gets "retired" at this point - kept on as a "second car" or "hobby car" to be used occasionally.  And when the owner goes to use it, they find it has a dead battery or won't start or needs work, and eventually, they realize that keeping this car is, in fact, costing them money and providing little or no transportation service.

Others keep throwing thousands at a car, convinced that "this time, for sure!" they will end up with a reliable car.  But unless they rebuild the car from the ground-up, reliability is never assured.

And often, people try to go cheap on repairs and end up spending more.  I used the example of the fellow with the Fiat, who replaced one ball joint at 115,000 miles and paid $250 for the privilege.  At 120,000 miles, he replaced another ball joint, and paid another $250.  Eventually, he got tired and sold the car to me.

I disassembled the entire suspension and rebuilt it - with new ball joints, tie rod ends, springs and shocks, as well as new trailing arms, sway bars, and sway bar bushings.  The car was tired and needed an overhaul, not merely "repairs".    Most consumers don't understand the difference, and when a mechanic presents an estimate for "repair" versus "overhaul" they go for the cheaper route, convinced they are "saving money" overall.

Related to this are Cascading Events, which occur when one item fails, leading to failure of other components.   A car overheats, because a thermostat gets stuck.  This may lead to a warped head, or excessive wear on the engine, which will manifest itself over time.  One thing leads to another, as they say, and the failure of a $5 part can lead to an expensive overhaul.

Repairing Repairs is another problem.  When a car gets to be a certain age, good quality parts are harder to come by.   And in this day and age, often the only parts available are cheaply made Chinese knock-offs.  Or many owners buy these cheaper parts, convinced they are "saving money".   Or often, rebuilt parts are the only real alternative, as new-car parts are so staggeringly expensive.

So you replace a serpentine belt and tensioner, because they squeak and it is annoying.   Two years later, the tensioner is weak again, and the belt is squeaking.  The OEM tensioner lasted nearly a decade.  The replacement part lasts only a few years.   And we see this a lot in aftermarket parts.   You end up doing the same repair over and over again.

And often, we see this with rebuilt engines and transmissions - which are not as high a quality as new ones.  With very old cars, you see that the original engine and transmission might have lasted 15 years and 200,000 miles, but the "rebuilt" versions end up lasting half as long.  Never assume that a repair will make things "as good as new" as it rarely does.

The Waddington Effect is another problem, and one I wrote about before.  Any time you put a wrench to a car, there is a finite (and highly probable) chance you will create one problem for every three or four you fix.  Col. Waddington noticed this on B-24s during WWII.  You take the cowling off an engine do to "preventative maintenance" and you snap off a cowling bolt.   Or you replace perfectly good spark plugs, only to realize you broke the connector on the spark plug wire.  

This is a common problem with repairing anything, and most folks simply don't "get" it, and blame mechanics when things "go wrong" on a repair.   But a mechanic cannot predict when a spark plug will snap off in the block anymore than they can predict lottery numbers.  Shit happens, as they say.

When I work on my own cars, I try to be careful - but I fully expect that when I tear down something, that odd are, I will break something else, and thus incur more expenses than I anticipated.

The best bet is to leave things alone, and a newer car, requiring less maintenance, has fewer of these sorts of problems.

Rule of Thumb?  I use a simple rule of thumb.  Rules of thumb are just that - not hard-and-fast rules, but good gauges to make basic decisions in life.    The 4% rule, for example, is good to use in retirement planning and post-retirement planning.   Is it exact?  Hell, no.  But you can't quantify everything in life, down to the last penny.

For cars, I use the rule that, if a repair cost exceeds market value, it is time to sell or scrap the car.   Why is this?  Well, there are a number of reasons.

First, if the repair cost exceeds the value of the car, chances are that means a fairly major repair.  And as I noted above, once a car reaches that end-of-life scenario, it needs not just one repair, but a number of major repairs and overhauls, often in quick succession.   This expensive repair could be a bellweather of things to come.  Think about what is "original" on the car that could go next.

Second, it could mean the car is worth hardly anything, according to the market.  Listen to the market.  When the market value on a car is less than $1000, chances are, it means not that people simply "don't like" the car, but that it is perceived as not having much life left in it, and is not a good transportation value.

At this price range, I often tell people, you are not buying the car so much as you are buying the repair rights to it - the right to throw more money at what is, at this point, going to cost you more in repairs than purchase price.

Third, the money spent on repairs can be better spent toward a newer car.   Thus, for example, my friend wrecks his Mercedes, and it will cost $5000 to fix it.  On a $50,000 car, this would not be an issue.  But on a $4500, 13-year-old, 180,000 mile car, not a sound use of money.   The $5,000 would be better spent buying a newer car, which would be more reliable and provide better overall economy.  The 180,000-mile car, even if repaired, would require additional repairs down the road.  Time to scrap it - or sell it to someone who will part it out, or can repair it on the cheap, themselves.

Getting Out Before:  Of course, it would be keen to sell the $4500 car the day before the $5000 accident, wouldn't it?  Similarly, it would be great if we could sell the $2500 car the day before the transmission goes South, right?  Or a month or year before, right?

And that is the problem, right there.  It is hard to predict when an expensive repair will be needed.  And when a car shows signs of needing an expensive repair, it is really unethical to sell it at that point, isn't it?

Trying to get those last few miles of "reliable" use out of a car is really difficult, and often not very cost-effective.

So, rather than wait for the expensive repair, it really makes more sense to sell the car before it reaches that stage in life.   You might not get much for the car, but on the other hand, you won't have to pay to fix it.

Handymen might buy such a car and fix it up - with their own labor - and thus get a good bargain.   But if you are not handy with tools, hanging on to an older car can be problematic, unless you are willing to drive it into the ground - and walk away when it needs a repair more than the resale value.

For most people, however, who want a reliable ride they can take to Disneyworld once a year, it makes more sense to sell before then - perhaps after 10-15 years and 150,000 to 200,000 miles.  Sell the car before you have to make that heart-wrenching decision of whether it is worth throwing a new transmission into it, rather than after it is all in pieces at the transmission shop.

But what about 300,000 miles?  Some car manufacturers are running ad campaigns suggesting this is a routine occurrence.  I am not convinced.  Most of these "high mileage" cars are not very old, and are not 20-30 years old, but rather were driven 30,000 highway miles a year.   If you drive like that, you should first ask yourself why, unless you are a traveling salesman.  It is not an effective use of your limited time on planet Earth.   But if you have worthwhile reasons to drive high mileage, obviously that affects the analysis, as highway mileage wears less on a car.  But nevertheless, striving for high mileage as a status symbol makes no sense whatsoever.  And yes, people do it, and put stupid little 'badges' on their grills when they reach certain mileage goals.

Cars do not last forever - or at least not in a cost-effective manner.  You can throw a lot of money at a car in an attempt to make it into a talisman or a hobby, but this is not sound and rational financial thinking.   And unless you can put three-million miles on a car and get paid by the manufacturer to drive around in it, such a scheme will not really pay off.

And no, the fact that you can put that many miles on a car made nearly a half-century ago does not say much about the products coming from the same company today.

Of course, there are other reasons to sell a car, besides the fact it is worn out.   For example, as a young person, you buy a two-door hatchback, which seems practical and fun at the time.  But then you decide to have a family, and trying to get a infant car seat in and out of the back is a hassle, so you decide to sell it for a four-door sedan, instead.

For me, the same thing happened with my pickup truck, shown above right before I sold it.  I kept it to haul trash to the dump and launch my boat.  But when we sold the lake house and the boat, keeping it made little sense.   And the transmission was starting to do funny things and the engine gave all the indications of needing a head gasket.   It would need thousands in repairs down the road, and I would have to park it outdoors in Georgia.   In short order, it would start to look like hell and be a real money drain.  The fact that the suspension was all-original was also a concern - tie rods and ball joints were no doubt in its future.

I sold it on eBay (disclosing the conditions to the buyer) and got some money for it.   It made no sense to "hang on" to a car I no longer needed that would need a lot of work to keep running in reliable condition.   The fellow I sold it to used it to, well, launch his boat and haul trash to the dump.  And he probably will get good service from it doing that for years to come.

Do I miss it?  Yes.  But then I think of the practicality of parking it in the driveway, the paint burning off in the Georgia sun, and the cost of putting in a rebuilt engine and transmission, as well as a suspension overhaul, and the like, and well, sentiment evaporates pretty quickly.

Would I sell my BMWs?  I will - someday.  When they are no longer practical for me, I will sell them.  And if they needed a new engine or an expensive repair exceeding the market value (which drops with each passing minute) - you bet.  There is no point in keeping something longer than necessary, if it makes no sense in your life or costs too much money to maintain.

I ran into this problem with my furnace at Washington Road.  Being an old HVAC tech, I kept it alive for quite a few years, nursing the fan motor back to life and carefully cleaning it every year.  But eventually, the heat exchanger cracked, and I realized it was time to call it quits.  And I was shocked to discover that a new furnace was not that expensive, and moreover saved enough money on our utility bills in the first year of use to offset much of the cost.

We rarely get emotional about furnaces - or refrigerators.  But for some reason, Americans have a huge blind-spot when it comes to cars.  We invest them with much emotion, naming them, and having affectionate feelings for them.  We make irrational decisions when buying them, repairing them, and selling them.   But they are just, well, cars - a transportation appliance that takes you from point A to point B.

And regardless of how emotional you get over "Old Betsy" - don't let that get in the way of your financial planning.  Because making emotional decisions about money is the one sure way to go broke.