Year: 2009

One of the prevailing wisdoms floating around the internet is that your best value when buying a car is to get one that is only 2 or 3 years old.  The idea is that you avoid some of the heaviest depreciation years in the beginning but the car should still have a number of good years left with minimal repairs.

I’ve been doing some thinking about this topic recently when I’ve been riding on public transit and have come up with the following thoughts which made me realize that this issue is far more complicated than just buying a late model car to get the best deal.

I’m not going to try to come up with a list of things you have to do to save money on your next car – there are many different situations out there and the fact is that a lot of people don’t necessarily want to save as much as possible on cars – they just want to get the best value for the money they are willing to spend – not everybody is flat broke.  The important thing is to consider these factors and include them in your calculations if you think they apply to you.

Car depreciation amounts per year

I did a bit of research on this and came up with a general rule that a car will depreciate about 20% per year.  Now, I’ve seen some ridiculous depreciation estimates like 30-40% as soon as you drive it off the lot.  All I can say is that if you know someone who is willing to sell their car for a huge discount after driving it off the lot then buy it.  Has anyone ever sold their car on the day they bought it?

This is just a rough estimate and given how poor new car sales have been, it’s not surprising that I’ve heard anecdotal stories that the difference in price between new cars and late model cars isn’t that large.  This is not a sustainable scenario however so I’ll stick with the 20% number for my examples.

How long do you keep the car?

I think the length of ownership is often more important than the age of the car when you buy it.  If someone buys a car that is only a few years old and keeps it for a short period of time and keeps buying more cars of the same age – do they pay less depreciation than someone who buys a new car and keeps it for the entire time?

I did a few calculations and I have to admit the results surprised me – I thought that a new car buyer who kept the car a long time would pay less (or the same) depreciation than someone who bought lightly used cars but didn’t keep them very long.  In fact, I was wrong.

Scenario I

• Depreciation rate is 20% per year.
• New car is $30,000.
• New car buyer keeps the car for 9 years.
• Used car buyer buys the car when 3 years old and sells at 6 years old – he does this 3 times.
• New car buyer pays $3486 more in depreciation (16% more).

This scenario doesn’t include potential repair costs which should be higher for the new car buyer – but it’s a moot point since the new car buyer has already lost the competition in the depreciation category.

Scenario II

• Depreciation rate is 20% per year.
• New car is $30,000.
• New car buyer keeps the car for 10 years.
• Used car buyer buys the car when 2 years old and sells at 4 years old – he does this 5 times.
• Used car buyer pays $7781 more in depreciation (29% more).

Ok, that’s the result I was looking for – of course this scenario is a bit silly.  I doubt there are very many people who buy 2 year old cars and only keep them for 2 years.  This scenario would need an estimate for repair costs as well since the new car buyer would have more of them in the end.

Scenario III

• Depreciation rate is 20% per year.
• New car is $30,000.
• “Buy and hold” new car buyer keeps the car for 9 years.
• “Market timer” new car buyer keeps the car for 3 years and then buys another new car.  He does this 3 times in total.
• “Market timer” pays $18,000 more in depreciation (70% more).

I’d be remiss in my blogger duties if I didn’t point out the extremely obvious comparison of two new car buyers – one keeps the car for a long time whereas the other keeps trading it in every 3 years.  Well guess what?  The guy who keeps the car for a long time pays way less depreciation.  Of course his repair bills will be higher but it’s hard to believe that they will exceed that amount of depreciation difference.

Reliability of the car

This is part luck and part design – you can research which cars are more reliable and buy one of those.  You will probably pay more for that car than one that is less reliable so it could be a trade off.  I don’t have any good advice here except to say that I hate paying for car repairs to the point where I might actually be better off just buying new cars and only keeping for 5-6 years just to avoid the aggravation of it all.

Gasoline costs

This cost is hard to analyze using a rule of thumb because it is so variable.  The price of gas alone is quite variable and of course some people drive very little – others will put many miles on their each year.  Some people do mostly highway driving whereas others will do more city driving which will result in poorer gas mileage.

That said, if you use the car a lot then you should factor in the gas costs into your analysis – but only if you have the option of buying different cars which get very different mileage.  If you are a soccer mom and have to decide between 2 similar minivans, then don’t worry about the gas costs since the difference probably isn’t worth worrying about.  If you are deciding between a Mini and a truck AND you are going to use it a lot, then you better factor in the gas when determining the cost of ownership.

In my ‘buy and hold’ example above – the total depreciation over 9 years was $26,000.  If you spend $240 per month in gas – then guess what you will spend over 9 years?….yup – $26,000.  $240 is a lot of gas for one month but some people do it.  Even if you only spend $100 per month – after 9 years, your gas total is almost $11k.  If you have the opportunity to save 30% or more of that amount then you should factor that into your analysis.

Size and style

Larger vehicles tend to be more expensive – are you buying a larger car by choice or situation (ie large family)?  If it is by choice then you should try to compare your large car options with possible smaller (and cheaper) car possibilities.  If you have already decided on the larger car then there is no point in this part of the analysis but it doesn’t hurt to know how much your choices are going to cost.

Luxury models are the same thing – obviously if you are shopping for an expensive BMW then comparing the cost to a Honda Civic is pointless but maybe you can look at other similar cars and see if there are better values available.  There is a difference between falling in love with a magazine picture and actually test driving her on the road.  And yes, I’m still talking about cars here!!  Keep your mind open…and out of the gutter!

Photo credit.

There’s a saying that when the economy turns bad, techies go to grad school which has definitely been true for me.  After the dot-com boom ended in flames, I headed back to school for my Masters, and by coincidence, soon after I started my PhD things turned south.  It worked out just about perfectly for my Masters, as 16 months later I graduated and companies had started hiring again.

If you want to read more about grad school from someone who has been through it all – check out the new site Ivory Tower Unlocked.

I have friends graduating, and finding academic jobs is VERY tough right now.  It’s a better time to be starting a program than finishing one, and if I was at the end of my undergrad I’d  consider carrying on to a Masters if I had the opportunity (and have been encouraging my PhD friends to consider doing a post-doc).

MBA programs are graduate school for business types.  They’re typically advertised as worthwhile after you’ve spent a few years in the work force, then want to put your career advancement on steroids.  Enough people bought into this that they’ve flooded the market with MBAs.  If the program content is good (makes you a better businessman) or if it’s now the minimum qualification needed to advance (an MBA is the new BA for upwardly mobile executives) it may still would be worthwhile going through a program.

Some people, talking informally, will suggest that the real value of an MBA program comes not from the classwork, but from having a chance to spend extended periods of time with people who are serious about moving up the corporate ladder.  Classmates today will be your network tomorrow, referring jobs to each other (as you reminisce about spending an all-nighter preparing an accounting project or getting drunk together on a Friday afternoon after your last exam).

There are MBA programs at a number of Canadian universities (Queen’s, York, Toronto, Ryerson) and internationally, with varying levels of prestige (and tuition).  Each asserts that their program will more than pay for itself in increased salary over the course of a career.  I think this is probably true for people who know that they want to be managers and spend a couple decades playing corporate politics.  If someone is happy doing specialized work (like a techie), and isn’t interested in becoming management, they should probably do graduate work in their own area.  I’m suspicious that entrepreneurs would be better served using their tuition money as seed capital for a business venture, but John T. Reed often refers to concepts he learned getting his MBA at Harvard Business School that he feels made him a better real estate investor, so there might be value in non-corporate areas of your life as well.

One of my friends is involved with The Rotman School of Business at the University of Toronto.  She’s working on a program which lets students get a taste of what an MBA would be like, by offering 8 three hour classes during evenings in the month of May.  Professors from the school lecture on their area of specialization and let a student know what it would be like if they took a program at the school.  It costs $3000, but half of this amount is credited towards tuition if the student then takes CERTAIN full programs at the school.  It’s like a less expensive “trial version” of an MBA.

While I’m totally biased, I definitely think this is a good way for someone living in Toronto to get a taste for what doing an MBA would be like.  If they’re on the fence, this could tell them (at a much lower cost) whether it’s worth making the time and money investment in an MBA or not.  Often companies are willing to foot the bill for education if you can sell them on how it would benefit the company over the long term.

Full detail about the program (and how to apply or get more information) is avaiable here.

The Financial Blogger is currently working on an MBA and has a number of posts on the subject.

For any readers who have done an MBA, how did you enjoy the program and did you think it was worth taking it?

Last week the Toronto Star broke the shocking news that Derek Foster had sold all his equity positions and was sitting in cash as of Feb, 2009. Currently he is selling put options on various stocks to make some money – a strategy he proposed in his third book Money for Nothing.

For those who don’t know who Derek Foster is – he is the self-proclaimed “Canada’s youngest retiree”, leaving the workforce at age 34 after accumulating a good-sized portfolio of dividend stocks.
His first book “Stop Working” was a pretty good read – although his math is suspect, he espoused a somewhat conservative dividend investing strategy and is also a big proponent of frugal living.  One of the keys to his strategy was to buy and hold stocks “forever”.

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To answer the title of the post – I don’t think dividend investing is dead – it’s not even “sleeping”.  Here are some thoughts:

Derek Foster wasn’t solely a dividend investor

Although Derek owned a number of traditional “dividend aristocrat” type stocks – he also owned a lot of income trusts which are far from dividend stocks.  Most of them are mid-cap (or smaller) companies that pay out a lot of return of capital.  He also got into a lot of option trading as well – which is clearly not dividend investing.  I think if he had stayed with more traditional dividend stocks, he might have had more luck staying in the market.

Diversification is good

I wrote a post a while back called “Ignore the last 10 years” which contained probably the best advice I’ve ever given on this blog.  I didn’t listen to my own advice and I doubt anyone else did either. 🙂  The problem with relying on a single investment strategy is that if it doesn’t work then you are screwed.

The last 10 years or so (ie 1997 to 2007) have been fantastic for dividend investors – especially in Canada.  Over the last year or two – a lot of investors piled into dividend stocks because they had done so well in the recent past.  This was in part because of Derek’s first book which another blogger has named the Foster effect.  This is a recipe for disaster as anyone who has invested in the Canadian banks knows.

Yes, their dividends haven’t been cut but it is no fun watching your investment sitting at 30-40% of your purchase price – dividend or no dividend, that is a bad investment.  We Canadian bank owners have been very lucky compared to the US bank owners though – I’m not sure if there is a single US bank remaining that hasn’t gone out of business or is owned by the government.  It is amazing how socialist America is becoming.

Derek didn’t follow the 4% rule.

The 4% rule is a basic guideline for how much money you can safely take out of your investment portfolio.  I don’t have the exact details but from what I understand – he was taking more than 4% which increases the risk that he will run out of money (or more likely – will have to change his strategy at some point).

Derek didn’t have much of a buffer

It was clear from reading his first book and several interviews that Derek knew how to live cheaply.  The problem with living cheaply however is that you don’t have anything to cut if times get tough.  Derek’s situation is hard to analyze because he made some money from his books.  Another big factor is that he is still quite young (late 30’s) so it’s not hard to imagine that he could easily get a job of some sort to help pay the bills which might mean that a big safety buffer is unnecessary.

Conclusion

Derek is doing fine – his strategy might have had a big downturn but he is a pretty smart guy and will do ok.

Dividend investing is still a perfectly valid strategy – but like any strategy you shouldn’t rely on it 100%.

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