Written by Trent Hamm, The Simple Dollar is a popular personal finance blog that chronicle's one man's road back from overwhelming debt to financial security. Hamm declared the contents of the blog to be in the Public Domain in 2008 and available for sharing when attributed properly. We will share a couple of posts a week.
I’m going to use a long example of a car purchase to start off this post. Bear with me through it.
Let’s say, for calculation’s sake, that a car has a life span of 200,000 miles before the maintenance issues catch up with it. For the last 40,000 miles of that drive, the reliability of the car is going to be seriously slipping, but up to that point, the car will be pretty reliable. We’re simply using this example for conversation’s sake. At the end of that life span, we’ll say the car is worthless, just for calculation’s sake.
You can go to a car dealer and buy a new car for $25,000. At this rate, every single mile you put on that car is going to cost you twelve and a half cents in car depreciation. We’ll call this Car A.
Alternately, you can go to a car dealer and buy a car with 100,000 miles on it for $8,000. In this situation, every single mile that you put on that car is going to cost you eight cents in car depreciation. At the 100,000 mile mark, you buy a replacement car for another $8,000, bringing your total car cost to $16,000 over that stretch. We’ll call this Car B.
Clearly, Car B is going to be the best value in this situation. For 200,000 miles of driving, you’re going to save $7,000.
Here’s where it gets trickier, though. In the second situation, you’re going to spend twice as many miles in the “danger zone” of reliability. 40% of the time, your car is going to have questionable reliability in the second scenario, whereas in the first scenario, it’s only in that “danger zone” 20% of the time.
Let’s add in another comparison. Let’s say you just sold off that $25,000 car at the 160,000 mile mark, which is the first time your car repairman told you that your car was starting to wear out. In this situation, your car would depreciate fifteen and five-eights cents every mile. Over the course of 200,000 miles, this plan would cost you $31,250. We’ll call this Car C.
In terms of pure dollars, Car C is going to be the most expensive option and thus the worst investment. If you view the value of a car as being strictly a means of getting from one place to another, Car C is a terrible option.
However, Car C spends no time at all in that reliability “danger zone.” It is constantly reliable.
So, for $31,250, you can have a car that gives you 200,000 with perfect reliability. For $25,000, you can have a car that gives you 200,000 miles with only the last 20% of those miles with poor reliability. Or, for $16,000, you can have a car that gives you 200,000 miles but it’s unreliable 40% of that time. We’re not counting any of the extra costs that occur when the cars are unreliable, either.
Which is the best deal? From a pure dollars and cents perspective, the $16,000 option is going to be the best deal. However, it’s not a reliable deal. It’s the one that’s going to give you the most failure in getting to your destination reliability.
What this decision really turns into is how much do you value reliability? How much more are you willing to spend to increase the reliability of your car and provide more assurance that it will get you to where you want to go over a long period?
Eventually, we always end up attempting to put a dollar sign on something that doesn’t have an exact dollar value.
All of us are in different situations. A single mother with three children, no relatives nearby, and only one car is going to value car reliability a lot more than a married couple with two cars, no children, and family members in town. Our income levels are also going to influence how much money we’re willing to put forth for some attribute that we value.
The biggest key to personal finance success is knowing what attributes are actually worth paying for in your life and which ones are not.
A name brand logo on a non-perishable item at the grocery store is probably not worth paying for (not without the product itself having real advantages). A fast food sandwich might be saving you time, but it’s costing you in food quality – so why not keep a bag of trail mix in your car (it’s faster and probably higher quality food at the same time)?
If you’re paying money for something – particularly when you’re paying more than another option – can you actually explain what you’re paying for?What are you getting that’s worth the extra money?
Sometimes, there’s a great answer to that question, and when you know that answer, it makes the more expensive purchase worthwhile. It’s also the reason why every purchase can’t always be examined through pure dollars and cents.
On the other hand, every time you can’t come up with a reasonable answer to that question immediately, it’s worth rethinking that purchase.