8

Aside from the horribly optimistic interest rate projections in the "Drive Free, Retire Rich" video, is this a plausible way to deal with auto expenses over one's lifetime?

The basic plan is:

  • get off the treadmill of buying a new car on credit every six years
  • don't trade your old car for a new car; instead:
  • save money for a year until you can buy a slightly better used car
  • do the same next year and you will have a reasonable used car and no debt
  • save all the money you would have spent on car payments compound in a mutual fund
  • withdraw from this fund every six years and you'll have a new car "for free"
  • after 30 years the fund will reach a million dollars

With the assumptions:

  • 12% after-tax average return on mutual fund investment
  • saving the US average monthly car payment of $425
12

Yeah, the 12% assumption is divorced from reality. That is a full 5% higher than the real return on the S&P for the last sixty years.

But buying a used car rather than borrowing for a new one is solid-gold advice. It may take more iterations to get to the nice car because of things like taxes, transaction costs, repairs, etc., but staying out of debt (or saving up as much as possible to get a reliable car) is excellent advice.

  • Repairs and taxes are a budgeting issue. Over the course of a year, I average $250 a month on insurance, gas, repairs and taxes. Driving a car is an expensive habit. The video states $475 a month is the average payment on a third of the cars on the road. This cost is just for the car. There is no guarantee that the market will pay 8%, but it's absolutely guaranteed that a car loan at that rate will cost that much. – SpecKK Aug 12 '10 at 15:53
  • The stock market has been averaging about a 4% real return (after inflation). – fennec Aug 12 '10 at 18:42
  • And this is not to mention that the fund can't be a tax-advantaged mutual fund if you want to withdraw from it to buy cars. So it's actually going to be well under a 5% real return. – poolie Nov 24 '10 at 3:44
7

Ramsey promotes Growth mutual funds and says he can screen out examples of good funds with a solid history of 10% returns in a couple of minutes on Morningstar.

The 12% in the video is fairly unrealistic, but 10% or 8% are realistic, especially when you buy into the market every month at all levels rather than chasing winners (buying high). At 10% you will still get $3 million in 40 years, and at 8% you'll get $1.5 million. You need to make sure you include reinvestment of dividends as well as mere price appreciation in these calculations of returns on investment.

So yes, you could probably drive really nice cars this way without breaking the bank. Like any financial endeavor, this requires hard work, patience and discipline. The actual work in this case would be fairly minimal in comparison to the patience and discipline:

  1. Set up direct transfers to a discount fund brokerage
  2. Find Funds and set up automatic monthly purchases
  3. Rebalance annually
  4. Pay capital gains taxes
  5. Route part of contributions to a cash fund a few months before you need a new car
    • Preferably when the market is up and from incoming funds.

If you get really lucky, you might end up with millions of dollars 40 years from now. If a health disaster, job loss, children's college, etc. strikes then you it might save you from financial ruin. Both are better than the rat race

I agree his predictions are too rosy, but this ad is an emotional sales pitch designed to change goals and behavior. Compare it to the psychology and unrealistic claims in some of the auto commercials you see on TV.

  • 1
    3 million from what level of monthly investment? – cgp Nov 3 '10 at 16:37
  • The video referenced calls $475 a month an average car payment. Compounding at 10% for 40 years would result in about 3 millions, but I'd have to find my spreadsheet to verify that. – SpecKK Dec 8 '10 at 0:06

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