Is buying a used car really all that important to your financial health? I’ve seen lots of articles and posts that say that financially responsible people buy only used cars. Being the data geek that I am, I was curious so looked into the question. In this post, I’ll provide you with my insights on the importance of buying a new vs used cars.

# Summary of Findings

Here are the important things I learned from studying this question.

- The cost of your car is more important than whether it is new or used. For example, you will have more savings if you buy a new car for $15,000 than a used car for $20,000, assuming you own them for the same length of time.
- How long you own your car can be more important than whether you buy a particular model when it is new or when it is three years old.
- The accumulation of savings from buying less expensive cars and owning them longer, especially after the compounding benefit of investment returns, can be significant though not as large as the amounts I’ve seen reported by some other authors on this topic.

The chart at the very end of this post illustrates these points (so keep reading).

# Cost of Buying A Car

How much you pay for a car depends on several factors – its make and model, how old it is, how many miles it has on it, whether it has been in an accident, among other things. It also depends on how you pay for it – cash, lease or borrowing – as discussed in my post on that topic. If one of your goals is to save as much as possible, you’ll want to buy the least expensive car that meets your needs, regardless of whether it is new or used.

The biggest argument against buying new vs used cars is that the value of the car decreases more per year when it is brand new than when it is older. This decrease in value is called depreciation.

## Depreciation

The chart below illustrates estimates of the patterns of depreciation for five different makes and models – a Subaru Impreza, a Ford Fusion, a Toyota RAV4, a Ford F150 and a BMW M4.

These estimates are based on a combination of data from Edmunds and the National Automotive Dealers Association (NADA). These two data sources didn’t have always values that were consistent, so I applied some judgment in deriving these curves.

The graph shows that all five models depreciate between 18% (Impreza) and 29% (F150) in the first year. In the next 10 years, depreciation is generally between 13% and 17% per year and is even lower when the cars are older than that.

## Depreciation in Dollars

To look at these values from a different perspective, I created the next graph that shows the dollar amount of estimated depreciation each year.

This chart shows that, even though the Fusion has the second highest percentage depreciation in the first year, it has the smallest dollar depreciation. When considering how much a car will cost you, it is the dollar depreciation that is important.

These graphs make it fairly clear that, if you plan to reduce the cost of a car purchase by buying used, you save the most money by buying a car when it is one year old. The amount you will save gets smaller with each additional year the car ages.

# Costs of Owning a Car

In addition to depreciation and, if applicable, finance or lease costs, there are five other major costs of owning a car – fuel, insurance, taxes and fees, maintenance, and repairs.

## Fuel

The cost of fuel (e.g, regular, premium or ethanol-free gas, diesel or electricity) will generally stay constant for each mile you drive, other than inflationary changes in fuel prices. For modeling the total cost of ownership, I assumed you will drive the same number of miles every year so the real cost of fuel will be constant. I used the first-year fuel cost from Edmunds True Cost to Own as the real cost of fuel in every year.

## Insurance

The portion of insurance that covers liability will likely be constant for a particular car in real dollars. The cost of liability insurance will be higher for makes and models of cars that are in more accidents (e.g., sporty ones) and larger cars (e.g., pick-ups that will cause more damage to another vehicle or more severe injuries). For my analysis below, I have used the first-year insurance cost from Edmunds True Cost to Own. I assumed that 40% of that amount was for liability insurance and would stay constant in real dollars. That leaves the remaining 60% for physical damage coverage which I assumed would decrease, in real dollars, in proportion to the value of the car.

## Taxes and Fees

Taxes and fees can be constant over time or decrease with the value of the car, depending on the state in which it is registered. For my analysis below, I used the first-year amount for taxes and fees from the Edmunds True Cost to Own. For subsequent years, I have assumed that taxes and fees, in real dollars, would decrease with the value of the car.

## Maintenance

This component of the cost of owning a car includes regularly scheduled maintenance and parts replacement, such as oil and other fluid changes, tire rotation, balancing, alignments and replacement, brakes, transmissions, tune-ups and anything else included in the maintenance schedule provided by the dealer when new. It excludes repairs for damage to the car and repair or replacement of parts not on the schedule.

I have assumed that the real cost for maintenance is fairly constant per mile over the life of the car. Because I am assuming that your annual mileage is fairly stable, I can assume that the real cost of maintenance is constant from year to year.

### Warranties Reduce Maintenance Costs

The significant exception is that many manufacturers include the cost of up to five years of maintenance in the purchase price of a new car. In my analysis below, I have relied on the information in the Edmunds True Cost to Own for the length of time that maintenance is covered by the manufacturer. After that, I used the average maintenance cost for the remaining years included in the Edmunds data and assumed it was constant in real dollars for the rest of the life of the car. I also assumed that the maintenance provided by the manufacturer is transferrable to a new owner.

If you are comparing the cost of a new car with that of a used car, you will want to make sure you understand which maintenance costs are covered by the warranty for each vehicle. For most of the cars in this comparison, the average annual cost of scheduled maintenance was estimated by Edmunds to be between $750 and $1,150 a year. The exception is the BMW for which the average annual cost after the warranty ends was closer to $3,000 a year. The maintenance covered by the dealer could offset some of the higher depreciation you experience in the first few years of owning a new car.

## Repairs

Repair costs include repair of damage to your car, such as cracked windshields, and repairs or replacement of parts that break. For my analysis below, I used the repair costs provided by Edmunds for each of the first five years after the car is new. I then looked at the results of a Consumers Report study to estimate how much repair costs would increase as the car got older. Based on that study, I estimated that repair costs increased about 4% per year in real dollars.

## Total

The graphs below show the components of the cost of ownership (excluding purchase price, financing cost and depreciation) for the five illustrative cars in each of the first and fifth years of ownership.

A comparison of these charts shows the much lower cost of owning a new car than a five-year old car if the costs related to its purchase are excluded. While the insurance goes down from the first year to the fifth year, the cost of maintenance increases significantly as the manufacturer is no longer paying for it. In addition, Edmunds shows no repair costs in the first year after it is first sold, but they can be significant, especially for the BMW M4, by the fifth year.

The chart below shows the total of these costs for each car by the number of years since it was new.

For most of these cars, the ownership cost is fairly constant starting in the second year. The Impreza, Rav 4 and Fusion all have annual ownership costs of about $3,500. The F150 has a similar pattern, but its annual ownership cost is closer to $4,500. The BMW M4 ownership cost is similar to that of the F150 for the first three years, but increases dramatically when BMW stops covering the costs of maintenance and repairs.

# Total Cost of Ownership

To provide insights on the long-term costs of different car-buying decisions, I calculated the total cost (in real dollars, i.e., without adjustment for inflation) of owning a car assuming the same choice was made for 60 years. I used 60 years as I thought it fairly closely represented the length of time people own cars – from the time they are about 20 until they are about 80.

In these comparisons, I included the initial purchase price of each car (using the new car costs from Edmunds and used car costs using my approximation of depreciation) and the other costs of ownership as discussed in the previous section. Also, whenever a replacement car was purchased, I assumed that the preceding car could be sold at the depreciated price.

## New vs. Used

The two graphs below show the total cost over 60 years of owning each of the five cars. The three bars for each car correspond to buying a new car, a one-year old car and a three-year old car. The first graph compares the total cost if you buy a replacement car every five years; the second, every 15 years.

If you replace your car every five years, it is clearly less expensive to buy a three-year-old car than a one-year-old car or a new one, though it becomes less important if you are buying inexpensive cars such as the Fusion. The difference between buying a new car and a one-year-old car is quite large for the F150 and the BMW, both of which have high depreciation in the first year.

If you own each car for 15 years, the benefits of buying a used car are much smaller. In fact, the increased maintenance and repair costs of buying a one-year-old car essentially offset the high first-year depreciation for the Subaru, Toyota and Fusion. Buying a three-year-old car is still clearly less expensive for all models.

## More Expensive vs. Less Expensive

The Subaru and Fusion are fairly similar cars – both are basic 4-door sedans, though the Subaru has all-wheel drive. If you don’t need all-wheel drive, you might be indifferent between the two cars. By comparing the total costs of the Subaru and Fusion in the above charts, you can see that the long-term cost of ownership of the Fusion is less than that of the Subaru. In particular, the cost of buying new Fusions is less expensive than buying three-year-old Subarus.

This comparison emphasizes the point I made in the Summary that the initial purchase price of your vehicle is a more important factor than whether you buy new vs used cars.

## Length of Time Owned

The graph below compares the total cost of ownership if you buy new cars and own them for different lengths of time.

The longer you own your cars, the fewer times you need to replace them. Replacing cars fewer times is less expensive over the long run, even though you get less for them when you sell them. One consideration when you own your cars for a long time is that you’ll need to save up more for the replacement car because you will get less when you sell the old car.

For the Subaru, Toyota and Fusion, there is a small difference in total cost between replacing your car every three years and replacing it every five years. For the BMW and F150, which have higher depreciation, the benefit of keeping your car for five years is larger.

For all five cars, you will save a significant amount over your lifetime if you replace your cars every 15 years as compared to replacing them every three or five years.

The graph below emphasizes the importance of how long you own your car. The blue bars represent the total cost of ownership if you buy new cars and own them for 15 years. The orange bars correspond to buying a three-year old car and replacing it every five years.

For all fives makes and models, replacing a new car every 15 years is about the same total cost or slightly less expensive than replacing three-year old cars every five years.

# Compounded Value of Savings

Many of my readers look at how much more money they will have when they retire if they make certain financial decisions. I think this perspective is terrific, as it focuses on long-term financial objectives. It also encourages financial responsibility in that these analyses assume that you will save the money in a tax-advantaged retirement account, such as an IRA or 401(k), rather than spend your savings on something else. My post at this link provides more information about tax-advantaged retirement accounts.

## Common Assumptions

I’ve read a few other posts that look at how much money will accumulate if you buy used cars instead of new cars and invest the difference in stocks. These posts tend to make the following assumptions:

- You have enough money to pay cash for a new car every certain number of years (such as 10), but buy a used one instead. One example I saw assumed that a three-year old car would cost 50% of a new car.
- You replace your car when it is a certain number of years old, such as 10, regardless of whether you buy it new or used (three years old, for example).
- You are able to invest the difference between (a) the stream of cash needed to buy the new car every 10 years and (b) the stream of cash needed to buy the used car every seven years in the stock market at 8% to 10%.

## Better Assumptions

There are a few aspects of this process that most posts I’ve seen overlooked.

- They exclude the cash you get when you sell your car.
- They overstate the cost savings from buying a three-year old car. My analysis indicates that cars depreciate between 35% and 45% in that time frame, not 50%.
- They ignore the other costs of ownership, especially the much lower repair costs and the maintenance costs covered by manufacturers’ warranties in the first few years of ownership.
- They ignore the riskiness of investing in the stock market. That is, if you invest the savings from buying a used car in the first year, there is as much as a 15% to 20% chance that you will not have enough money in the seventh year to replace your used car.

In the discussions below, I will use essentially the same paradigm, but will refine some of the assumptions. In particular, I will revise the investment assumptions so they:

- better reflect the cash flow needs,
- use the higher purchase costs for the used car,
- include all costs of ownership, and
- eliminate the risk that you might not have enough money to buy your second car.

This analysis is simpler than it could be. In the entire analysis, I stated all of the cash flows in current or real dollars. That is, your actual savings will likely be higher than is estimated in this analysis because, with inflation, the cost of the more expensive strategy will be even more expensive than if we had assumed that all costs were subject to the same inflation rate.

## Reasonable Investment Assumptions

To avoid the risk that you won’t have enough money to pay for the second used car, I will assume that you can earn 3% in an essentially risk-free investment for the first 10 years (until you replace your new car for the first time). In the current interest rate environment, you can earn close to 3% on CDs, corporate bonds or high-yield savings accounts. After that, you have enough savings built up from buying two used cars instead of two new cars that you can afford to take on the risk of investing in the stock market.

I have used the annual returns on the S&P 500 from 1950 through 2018 to model the amounts you will have accumulated by selecting the less expensive strategies.

## New vs Used Cars

For the first comparison, I will look at the example discussed above – buy a new car every 10 years or a used car every 7 years. In this comparison, I calculated how much you would have at the end of 40 years if you invested the difference between the new car costs and the used car costs. For the first 10 years, I assumed you would earn 3%. For the remaining 30 years, I used the time series of 30 years of S&P 500 returns starting in each of 1950 through 1968 (for a total of 39 time series). To reiterate, this comparison assumes that you invest the difference in a tax-advantaged account and don’t spend it on something else.

If you buy used F150s instead of new ones, the historical stock market returns indicate that you will have an average of $390,000 more in retirement savings at the end of 40 years with a range of $200,000 to $800,000. For the Subaru, the average is $160,000 in a range of $75,000 to $350,000.

This analysis indicates that, if you prefer to drive fairly expensive cars that depreciate quickly when they are new, you can accumulate a substantial amount of money if you buy used cars for 40 years. For less expensive cars that don’t depreciate as quickly, the additional savings amount isn’t as large but is still significant.

## More Expensive vs. Less Expensive

You can get almost as much additional retirement savings if you buy a less expensive new car and own it for 10 years as you can if you buy the used F150 instead of a new one and more than if you buy a used Subaru instead of a new one. For example, if you buy the Fusion (currently about $15,300 new) instead of the Subaru Impreza (currently about $26,000 new according to Edmunds) every 10 years, you would have an average of about $300,000 more in retirement savings. That additional money comes from:

- the $11,000 of up front savings from the first car purchase,
- the $8,000 of savings for purchase of the three replacement cars after trade-in,
- the $250 to $350 a year less it costs to own the Fusion, and
- the investment returns on those savings.

This analysis shows that you can save more by buying a less expensive new sedan (the Fusion) every 10 years than by buying a three-year old Subaru every seven years. That is, if instead of buying new Subarus you buy new Fusions, you will have an average of $300,000 in additional retirement savings, but only $160,000 if you buy used Subarus.

## Length of Time Owned

You can also accumulate savings by buying cars less often. For this comparison, I looked at comparison of buying new Subarus and F150s every five years and every 15 years. If you replace the Subaru every 15 years, you will accumulate an average of $300,000 of additional retirement savings in 40 years as compared to replacing it every five years. With the faster depreciation and higher cost of the F150, the average additional savings in 40 years is about $600,000.

## Comparison of Options

The box and whisker plot below (discussed in more detail in my post on risk) compares the amount of additional retirement savings you will have under the options above. Briefly, the boxes represent the range between the 25^{th} and 75^{th} percentiles, while the whiskers (lines sticking out of the boxes) represent the range between the 5^{th} and 95^{th} percentiles. Recall that the only source of variation in these results is the different time periods used for stock returns – the 39 30-year periods starting in each of 1950 through 1988.

The first three boxes relate to the purchase of fairly modest sedans – the Subaru and Fusion. The graph shows how much more retirement savings you will have if you either buy new Fusions instead of new Subarus (second box) or replace your new Subaru every 15 years instead of every 5 years (third box) than if you buy three-year-old Subarus instead of new ones (first box).

The last two boxes relate to the purchase of the more expensive F150. Again, you will accumulate much more in your retirement savings if you replace your F150 every 15 years instead of every 5 years (last box) than if you buy three-year-old trucks instead of new ones (second to last box).

# Final Words

Ultimately, you’ll need to buy a car that best fits in your budget and meets your needs. As you make your choice, though, you might want to remember that there are clearly ways you can save money even if you prefer to buy new cars.