Buying an Expensive Car vs. Cheaper Car

4 Apr 2008 by Chetan Shah.

I understand lot of individuals are car lovers and crave to have an expensive car like BMW, Lexus, Acura etc. Personally I consider car as purely a tool to take you from point A to point B. No wonder I bought a Toyota Corolla in 1999 and still is serving me well without any maintenance problem of *any* sort.

In economics there is a term called Opportunity Cost and I think it is relevant in this case of also. By buying an expensive car an individual forgoes the opportunity to invest that extra money in something which could in future give decent financial returns.

I am basing my discussion on the fact that Toyota Camry costs ~$21000 and Cheapest BMW model costs ~$33000 . Therefore you will have ~12000 to invest somewhere else. This is assuming that you have the capacity to do down payment for both the cars, which people like me will never be able to. So in that case, you will paying interest on the car loan. Needless to say you will pay more in interest for an expensive car as compared to a cheaper car. So the effective cost of your dream car (BMW in this case) will be much higher depending on the interest rate you lock in.

Following are some of the things which could be bought instead of buying an expensive car.

- Mutual Funds / Stocks / Exchange Traded Funds : If you do not know which mutual fund to buy just pump in cash in S&P 500 index fund and forget about it till you are really in need of cash (Remember : urge to buy a new car every 5 year does not count as a need), if you are an A+ investor (unlike me) most probably you would not be reading this as you would have already figured out how to invest your hard earned cash effectively.

- Buy a home (if you are renting one) / rental property (if you already have purchased a home) : Buying a house is a perfect thing to do in *any* market. It is imperative to build home equity if you are renting currently. In addition to building equity, the government will give you a tax break for the mortgage interest which will not be the case if you buy a car. If you already own a house, buy a rental property with the money saved by opting for a cheaper car. Having a renter pay for your rental property sounds like a win win situation to me.

- Max out your 401(k), IRA etc.: Before thinking of sinking money in a BMW, please ask these questions to yourself
- Have I maxed out my 401K, IRA ?
- Do I have adequate life insurance to support my family in the event something happens to me?
- Will I have enough funds to give my kids excellent education?
- Have I taken my family to vacation outside of my home country (I strongly believe that
traveling outside your home country spawn new creative thought processes)
- Have I donated money to charity?
- Do I need to get higher education to make me more competitive in this tough market?

Fidelity’ Investor Quarterly (go to page 10) did a research study on how much it costs to replace a car every 4 years. This will give you a general idea of what you will losing by buying an expensive car instead of cheaper car.

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