By the end of 2007, I plan to have $20,000 in my emergency fund. (Remember, I “borrowed” some money from my Emergency Fund so that I could fully-fund my Roth IRA’s for 2006. I am in process of “paying myself back”.) Since I’ve been thinking about purchasing a “new” car, I started thinking about how rapidly I could save $10,000 by the end of 2009.
First, I found this awesome calculator and I entered the following:
Number of years: 2 (January 2008 until December 2009)
Annual Rate of Return: 4.5% (Current ING Direct Rate)
Opening Balance: $20,000
Monthly Savings: $325
Ending Balance: $30,025.61
For the 24 month period from January 2008 until December 2009, I will deposit a total of $7800 ($325 X 24). Adding that to the amount of interest that I will make during that same period of time (about $2200) and I will arrive at my grand total of $10,000. So, in two years, I could purchase a $10,000 automobile after making $7800 in “payments” to myself.
Notes: The above calculations assume that I will NOT have to use my emergency fund funds for any other purchases, that the interest rate in my ING account will not dip below 4.5%, and does not include tax that I will pay on interest earned.
Now, let’s assume that at the beginning of 2008, I decided to finance an automobile and that I wanted my payments to be $325 per month. How much of an automobile could I afford? Just for simplifying the calculations, let us assume that I am going to get financing at 4.5%. I realize that this number is “low” for a used car, but let’s just keep things “simple”.
I could FINANCE the purchase of a car at 4.5% for 24 months, with payments of $325, and I could buy a car valued at $7445.
Over a 24 month period, I would make 24 monthly payments of $325 (totalling $7800). Over that same time, I would pay the finance company $353.95.
So, the difference, in this example, between saving $325 per month (and adding this money to the interest that my savings account is already accruing) and financing a car purchase for $325 per month, is about $10,000 – $7445. So, by saving for my purchase, instead of financing it, I can get $2500 MORE car.
Notes: Using my method, I will have to delay the purchase of the car for 2 years. But, whenever I make the purchase, I will be getting a ‘nicer’ car.
Now, suppose that, instead of sticking with the $325 payment, you simply wanted to purchase a “$10,000” car, financing it at 4.5%. Now, what would be your total cost?
I could FINANCE the purchase of a $10,000 car, for 24 months, at 4.5% with payments of $436.48. Over the life of the loan, the total amount of payments plus interest would be $10,475.52.
Now, back to my plan. In two years, I will have turned $7800 plus interest into about $10,000. If I were to finance a $10,000 car at 4.5%, I’d be “out” $7800. That, my friends, is a $2600+ difference!
The above just gives a taste of the power of interest working FOR me instead of AGAINST me. In the “real world”, I hope to make a better return on my money than 4.5% and there are very few people who qualify for used-car loans at 4.5%. So, the difference in the “real world” would probably be MORE than I have figured. (I used the calculator located here to figure loan payments.)
Resources:
The power of cash is pretty outstanding … also consider the extra negotiating power you have with cash. On several occasions I have gone car shopping under severe weather conditions (105 degree heat or in the middle of a snowstorm) armed with cash and I always got an outstanding deal, well below blue book.
The one thing I would counsel is to avoid thinking of your emergency fund as an extended savings account. Consider that an emergency could occur inbetween the time you ‘borrowed’ from your fund and the time that you have ‘paid it back’. That is taking risks that don’t need to be taken.
Really like the post, gives the rest of us paupers a reason for hope about saving for a car. One question, although you sacrifice two years time to “wait” to get a better car ($10,000 car instead of $7,445), does it take into account TVM? I think you are comparing $10,000 in 2 years to $7,445 now, but $10,000 won’t be worth quite as much in 2 years, if I am going thinking about this correctly. Anyway definently a great example either way of the power of interest in your favor.
Bear in mind that the interest you earn on your savings is taxable so that will either reduce the amount you will have for a car below $10,000 or reduce the amount of money you have for other things if you pay the taxes from other income. Still your approach is a good one!
Yes, TMV does come into play, but I would, of course, ACTUALLY put back a bit more than 325… I was just keeping things “simple” for the example…
Taxes are always changing, so, again, to keep it simple, I did not really mention them… the calculator that I give in the example will figure taxes, if yo want it to do so…
Reread my comment … I don’t want anyone to think I’m insulting NCN. What I’m saying is that I disagree with the concept of saving as a way to earn money. Buying the car is fine, and saving for it or taking a loan is certainly required for most of us. However the strategy of buying a $10K car for under $8K by saving is what I think needs to be analysed a little more; $10K will be spent at the time of purchase and every penny will be earned through a sacrifice of some sort.