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May 11, 2018

Make Depreciation Work for You

Depreciation has been discussed a lot by financial types, but I recently sold our Mazda Miata and it got me thinking about it, so I'm going write about depreciation today.

As you probably know, depreciation is when something loses value over time. We like to track depreciation over time using graphs. We call the line on the graph the depreciation curve, which you can see below.

Most commonly, depreciation is associated with automobiles, but it applies to everything. Depreciation is what makes any used item less expensive than a new item, which is why we love buying used things. Since cars are usually the most expensive thing people own aside from their home, they pay a lot of attention to the depreciation, so that's what I'm going to focus on here.

The average price of new cars sold today is about $36,000. The graph below shows the expected depreciation for that average car:

Looking at the graph, a few things become clear.
  1. Depreciation begins immediately and is fastest right after the car is first sold. That means you can save a lot buying a car that's only a year old. In this example, you would save almost $7,000.
  2. Many people believe the "sweet spot" for used cars is 3-5 years old. That's because the rapid initial depreciation has already occurred and future depreciation is much slower. The car also has a lot of useful life left at this point. In this example, the car is worth almost exactly half it's original price after four years. That equates to a savings of $18,000 if you buy the four year old car.
  3. There are huge savings to be found if you buy a car that's 10 or more years old. This is where depreciation really slows down, so not only do you save a lot on the initial purchase, you can also sell the car after a few years for close to what you paid. This is the area I want to discuss in my real-life example below.
Depreciation in the Real World
The numbers I was using above are theoretical averages. In reality, depreciation varies widely. For example, Toyota Tacomas depreciate shockingly slowly because they are known to be incredibly reliable and useful vehicles. On the other hand, pretty much all luxury vehicles depreciate very quickly because they are notoriously unreliable and expensive to fix.

A wise car shopper will take depreciation into consideration when buying a car. It might actually make sense to buy a new Tacoma because you don't really save much buying a used one, however, it is pretty silly to buy a new luxury car since it's value will plummet when you drive it off the lot.

This is one of the major things I was considering when I purchased our 1994 Miata back in 2014. Since the car was 20 years old at this point, it was pretty much at the bottom of the depreciation curve. I was confident I could sell the car pretty much any time for close to what I paid for it, and that turned out to be the case. We paid $4,100 for the car and sold it almost four years later for $4,000. 

Most financial bloggers say cars are a huge waste of money, but we only paid $100 in depreciation for four years of fun driving. In my opinion, that's not a bad investment at all. On the other hand, we also paid about $1,000 in insurance, registration, and maintenance over that time, so the investment doesn't look quite so good when you consider that.
A couple more great examples from our lives are our truck and camper. Our truck was 15 years old when we bought it and our camper was just over 20 years old. Both of these are pretty much at the bottom of their depreciation curves, and will more or less hold their value as long as we maintain them. As I've mentioned before, the savings on the initial purchase of these items was staggering. We paid a total of $13,800 for both. Compare that to the new cost of at least $80,000 for new equivalent items today and you can really start to appreciate the power of depreciation. Sure, older vehicles require a little more money and effort in upkeep, but I think the $65,000+ in savings are worth it, and we get just as much utility from our old truck and camper as we would from new ones.

At this point, astute readers may be wondering why we recently bought a brand new car if used cars are so great. In short, we got such a good deal it was kind of like buying a used car. It also had features we really wanted, like Android Auto and a "proximity key," that weren't readily available on older cars. Finally, we decided it was alright to splurge a little on our primary vehicle.

The moral of this story is you should strongly consider buying fully depreciated assets. Just do your homework so you only buy reliable products and not pieces of junk (lots of things depreciate quickly for a reason). This strategy worked out very well for us on our Miata, truck, camper, and a whole bunch of other stuff.

Have you had good luck buying depreciated assets? Let us know in the comments.


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