The Dollar Rule

Submitted by George on Tue, 2008-10-21 01:05

The Dollar Rule vs. Your Car

At the Dollar Rule we're not content to analyze smaller purchases like iPods or movie tickets. We want to see how well (or poorly) the Dollar Rule stands up against even very big ticket and infrequently purchased items. This way we can figure out if Dollar Rule needs tweaking, or if it's still valid even with a few extra zeros on the end of the price tag.

As a science analogy, the Dollar Rule in it's current state, could be compared to how physics was in the 17th century. In 1687, Sir Isaac Newton introduced his three orderly laws that every object in the universe seemingly obeyed, from pebbles to planets. Yet, it wasn't until much later in the early 1900's that Einstein and others found that Newtonian physics only applied to mostly to everything. Once you got on the atomic level, the everyday laws of physics went completely out the window. And on the other end, if you started to consider very large massive objects and/or approached the speed of light, all sorts of weird stuff starts to happen.

We won't presume to be at the same level as Isaac or Albert, but we do want to test the outer limits of the Dollar Rule and see where it starts to break down, if at all.

Cars

For our main example we'll consider a typical sedan such as the 2008 Honda Accord LX, most basic Accord trim package, which has an approximate going price of around $20,360 (all prices taken from Edmunds.com).

As with all of our case studies, we first ask how long it take to reach the 1 use-hour per dollar of cost, which would meet our defined minimum DRR of 1.0 to make the purchase dollar-worthy.

So for a $20,000 car, when would 20,000 hours of use be reached our minimum DRR of 1.0? Theoretically, the shortest possible time would be if you drove it 24x7. Driving continuously it would take 833 days or 2.2 years to reach the break-even point. And you thought NASCAR races took a long time to run.

More typically, let's say you drive your car 2 hours a day. So that's 20,000 / 2 hrs per day = 10,000 days. How long is 10,000 days? That comes to 27.4 years! And that's assuming you maintain the average 2 hours of use every single day (7 days a week). How many people do you know that keep a car that long? Probably not many.

Even if you figure you do a lot of driving every day and double it to 4 hours per day, that's still 5,000 days or a good 13.7 years. But at least 13.7 years is more in the realm of possibility. It's not uncommon for people to drive their cars 10 or more years.

Now as the astute Dollar Rule reader will notice, so far we've only assumed that a single person is using this car. As per our refinement of the Dollar Rule, if more than one person is getting use out of the car (even at the same time), then you should be counting the total use-hours for all the beneficiaries and not just the driver or owner.

Family Car Scenario

So let's see how much faster we can reach a DRR of 1.0 if we consider a family of 4. If we still only drive the car 2 hours a day, assuming all 4 people are in it the entire time (for the sake of making the math simple), then we're getting 8 person-use-hours out of the car each day instead of just 2.

At 8 hours per day, the 20,000 hours is chewed up in just 2,500 days, or 6.8 years. So for a family of four, seven years is certainly within the timeframe that many people keep their cars. So if you're single, I guess you need to get some carpooling buddies :) or just plan to drive the thing into the ground.

Of course, the more pragmatic approach is to simply buy a cheaper car. It doesn't mean buy a lesser car necessarily, just cheaper. For example, if you buy the same car but get a lightly used model that's a couple years old, you'll like shave a good chunk off the price of the car.

Total Cost of Ownership (TCO)

However, before we pat ourselves on our collective backs, we need to realize that our basic premise is far too simple. For one thing, we're haven't been counting all the costs that come with ownership of a car. Unlike most purchases, the price tag is only the beginning. Cars have a lot of ancillary costs associated with owning them:

• Financing costs (unless you paid all cash up front)
• Fuel costs (ouch)
• Maintenance and repair costs (tires, oil changes, brakes, fluids, etc.)
• Insurance premiums
• License or tag fees
• Taxes (if you live in a state that charges ad valorem or luxury taxes on vehicles, the more your car is worth, the higher your tax on it. Sucks, eh?)

If you spend even $40 per week on gas, that's over $2,000 a year for fuel. Insurance might be another $1,000 per year. So those two items alone would be $3,000 x 10 years = $30,000, which would put our total cost of ownership (TCO) at $50,000 at a minimum. Toss in maintenance and repairs, and the other items and $60,000 would not be that far-fetched an amount for the TCO of a $20,000 car over 10 years!

But on the positive side, the benefits we gain from the car is perhaps not just limited to the 2 hours a day we actually drive it. If your car is what enables your kids to get to school, gets you to the office, and let's you run errands, then you could somewhat argue that the amount of time you benefit from the vehicle is 2 hours commute + 5 hrs of school per kid + 6-8 hrs at work. Wow, that could add up to 20 hours of use in a single day? However, the 20 hours will get averaged down to 14 use-hours, since we would be spreading that time across all 7 days of the week, to use in our calculations.

So if we take these two extreme limit numbers ($60,000 for the total cost of ownership and 14 person-hours of use per day), that comes out to 4,286 days or roughly 11.7 years. This would seem to say that a $20,000 car might be a break-even deal for a family of four, assuming you keep the car more than 10 years.

If we consider a more upscale car, like a $40,000 BMW 3 Series, we can take the 11.7 years we got for a $20,000 car (to reach DRR of 1.0) and double it to 23 years. Similarly for a $10,000 car (say a Kia Rio) we'll just halve the time and get just under 6 years.

Or let's say you stick with the Honda Accord but opt for a better trim package in the EX-L model. That would bump your lifetime cost to $65,000. At 4 hrs per day the $5,000 would add 1250 days or almost 4 years to your DRR 1.0 time. Or if we use the 14 hrs per day rate, then it only adds 357 days (~1 year) to the DDR 1.0 time. Hopefully the upgrades in the better model makes it more likely that you'll want to be in the car for those extra 1 - 4 years of extra time you'll need to (or should) own it. If it's something like adding air-conditioning and you live in a hot climate then it's probably not a bad investment.

But the $60,000 I used as the total-cost-of-ownership is quite a guesstimate. You probably ought to calculate the numbers that are specific to your car and situation (insurance, gas, etc.) and see what your real TCO is.

Also, we haven't even considered leasing a car instead of buying it, but that's a whole different topic (you might read this Buying vs. Leasing article at Edmunds.com.

For a list of various metrics that can be applied to car ownership look at the Car Almanac, which is kind of biased towards using non-polluting, non-fossil fuels (i.e., ride a bike), but it's interesting reading nonetheless.

Pass or Fail?

I'm sure this won't be the end of our discussions related to cars and other transportation (mass transit, bikes, etc), but for now I would say this was a decent test for the Dollar Rule. Part of the problem is how one defines "usage" or "benefit, when we try to determine how many person-use-hours we can attribute to using the car.

But as we've said before, the Dollar Rule is to help provide some standard comparisions of what you're getting out of your money, no matter what you spend it on. If you want to think that your car gives you 20 person-use-hours per day, that's your prerogative. We're not here to babysit anyone. But it's also your wallet! So you have to be completely honest with yourself when making some of these assessments about your time and money. Being completely honest about your money is one of Suze Orman's mantras -- and she's right!

Anyway, later on we'll pit the Dollar Rule against even bigger purchases.

 Tags:

• car
• driving
• money
• tco
• time
• total cost of ownership

 

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