New or Used? The car question examined.

So a car may be a depreciating asset, but how can we make the most of it. Or how can we minimize the cost to own a car. Well the obvious answer, get a cheaper model. OK, duh, but what then?

Assuming you'll always have a car, this means the cost to own can be broken down to a per-annum (yearly) basis. So if you go with a pattern that ends up costing you the least money per year on average, then you're paying the minimum amount overall. So onto the math and hand waving (this is just a very broad overview because there really are many, many specifics that can affect what the optimum is).

Firstly, leasing a car is something many of us frugal people discard as too expensive.

Well, lets examine why this is so. The way a car lease really works is that you're paying for the devaluation of the car while you drive it. Basically your total cost of the a 5-year lease is the (new car price) - (5 year old car price). To me this sounds equivalent to buying a new car then selling it after 5 years. In fact it largely is, many leases have an option to pay the remainder to the residual price to own the car outright. In essence you just took 5 years to buy the car. Now this usually ends up costing more due to how dealerships do the financing and such, so you're still behind compared to just buying it in the first place.

So now we have to ask, why does buying (new) and selling every few years do worse than keeping one car for that long?

The trick here is that cars depreciate non-linearly. To go back to leasing, there is something called gap coverage. This exists because the car initially depreciates faster than the constant monthy payment you make. So the initial depreciation is fast, then slows down. There is the saying that just driving a new car off the lot loses 20% of its value.

So since a car's value roughly models an exponential decay function. So by that, the oldest car you can get is the best deal. With less value to lose, your cost per each year of ownership due to depreciation is minimized.

But wait, there's the major factor of maintenance costs to add. And these generally rise as the car gets older. So we're now calling the total costs to own a car for a year the depreciation + maintenance. After the initial few years, when the car is done rapidly losing value, the rising maintenance costs will act to stabilize the cost per year.

So it looks like the optimal value is to buy the car at least a few years old and keep it until... when? Well if we consider the cost per year as a car's price. Once maintenance costs rise enough that the total cost will exceed the cost per year of getting a new(er) car, you should give up and trade it in. In the case of deciding whether or not to even do a repair you need to weight that repair cost against the difference between the amount you'd get for a running version of the car, versus it dead (you could still get money from selling it for parts to the scrapyard)

It's also worth it to note that there are several influencing factors in this calculation. Firstly the assumption made is that the new car is similar to the old one. If it's not, things like gas mileage, warranties and the like can influence the cost curve. Also because of things like taxes and fees, you are encouraged to hold on to the car longer so as to spread these out over longer periods. So even in the ideal case you're not buying and selling your car every year.

Now all that said, it really depends on the specifics of the car to know what is a good buy. Of course you can't really know what a 5 year old model's value will be in the next 10 years, but you can look at the other older models to get a good guess. Furthermore, even given figures are just averages, the condition of the car will cause a lot of individual variation.

On a final note, this article on Edmunds shows that not all depreciation are equal, and it's possible to do this buy and sell strategy earlier in the life of some models. (Keep in mind though that newer used cars can be difficult to find) Also the total cost of ownership calculator is great for providing the estimates to make your own assessment of the cost curve of any individual model.