Let's start with a short story about my friend. We'll call him Vikas. He is from a middle-class family who graduated in engineering from Mumbai University in 2014. Vikas didn't have an education loan or any other loans for that matter. After graduation, he got a job in one of the software companies with a package of around five lakhs per year. This was a respectable package back in those days. In the first year of his job, he saved around two lakh rupees i.e., almost half of his salary before taxes. Saving 50% of our own salary is a great start and shows financial prudence. The story doesn't end here. In the second year, he spent all his savings in the downpayment of a car worth ten lakh rupees and took a loan for the remainder amount. He went from a positive net worth of 2.5 lakhs to a negative worth of 7.5 lakhs.
Vikas used that car for couple of days a month. Once a year, he might go for a vacation of 7-8 days, but that's it. This is a very typical story with our friends and many times, ourselves. Is it worth to buy a new car on EMIs when we rarely use it for the commute? Wouldn't it be better to buy a used car? Most of us make these decisions emotionally. When we buy a car, the moment it comes out of the showroom, the value of that car decreases by 40%. When we own a house, the value might appreciate over the very long-term. But a car's value always depreciates the longer we own it.
Vikas took a loan of 7.5 lakhs at the rate of 9.75% for six years to own a car. Below is the detail on his EMI and total payments over those six years:
Vikas paid back a total of 10 lakhs in those six years. The total cost for the ownership of his car comes around 12.5 lakhs. I am not even considering the fuel, parking charges, service, PUC, and a ton of other things that come with car ownership.
Depreciation is a reduction in the value of an asset over time, due in particular to wear and tear.
I avoid buying depreciating assets on EMIs. Car is a usable product, but it depreciates in value. I am not saying that we should never buy a car. My only concern is that we spend most of our accumulated savings in buying such a depreciating product. Instead we should be investing our money to beat inflation.
Even if we spend fifteen thousand rupees per month on Ola/Uber, it will take us around six years of using cabs to justify the cost of merely owning a car without considering the fuel and maintenance expenses. I don't own a car because I cannot justify its expense or use. Do I want to own a car? Definitely YES! Do I want to buy on EMIs? NO!!
Other examples of depreciating assets are cell phones, devices, clothing, luxury spends, etc. The problem is not with splurging on these things. I spend on these said examples, but it doesn't cost me all of my savings or erode a significant percent of my net worth.
I am not an idealistic person who doesn't own any depreciating assets. My depreciating assets include an iMac, costing around 1.60 lakhs. I have the latest iPhone charging me around 1.20 lakhs. But I never bought them on EMIs. I paid in full! Buying them didn't deplete all of my savings.
I love to spend on good food. I eat at high-end fancy restaurants once every two-three months. I could splurge on fancy things because I didn't pay all of my money in a depreciating asset like a car in an instant. Experiences matter to me more than things.
It's fine to splurge on things that you love if you can afford them! Don't try to keep up with your neighbours. Understand what matters to you!
I definitely want to own a car sometime in the future when I can pay it in full. My personal rule is to not own a car until the ownership cost is not more than 10% of my net worth.
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