Understanding Total Cost of Ownership
When you are shopping for a car or trying to decide whether to keep your car or move to a newer one, there is one simple concept that you must understand: total cost of ownership.
Total cost of ownership takes into account depreciation, operating costs, repairs, maintenance and insurance costs. To make comparisons, you would calculate a cost per mile driven or cost per year of ownership.
Depreciation
I’ve already mentioned depreciation, and will continue to mention it because it is just so important to keep in mind. This cost will be the single biggest contributor to the total cost of ownership if you are driving a relatively new model (within 5 years old or so). If you made the mistake of buying brand new, it will be an even larger contributor.
Operating Costs
Operating costs are things like fuel, tires, brakes, and oil changes. These are wear items that are consumed on a day to day basis and make up a large chunk of your costs as well. Fuel will be the biggest cost here. If you drive a car that has different tire sizes on the rear compared to the front, you should break those costs out separately since they will wear at different rates.
Repairs
It’s hard to know how much repairs will cost you since they are by nature unpredictable, but you can get an idea based on how expensive the car itself is, its reliability rating, and by reading surveys from Consumer Reports.
Maintenance
Maintenance costs are predictable, since typically you know how much you drive in a given period, and that your car will require an oil change every 3,000 miles (or much longer if you are using a synthetic oil), your car gets a certain number of miles per gallon, etc.
Regular service inspections also fall under this category – these might be every 30,000 miles or so and cost in the neighborhood of $1,000 each, depending on what kind of car you are driving.
Insurance
Before moving to a different car, you definitely will want to know what the insurance will cost you. You can find this out most often by requesting a free quote online from major insurance providers.
A recent study by Consumer Reports uses slightly different categories than I have just described, but the basic conclusion is the same: depreciation and fuel are the biggest costs during ownership, making up 46% and 26% of the total cost of ownership, respectively.
Source: Consumer Reports, 2008
Focusing on reducing depreciation, therefore, will lead to a huge savings over the course of your owning a car (Ramit Sethi would call this focusing on the Big Wins). This is why, when gas prices were up around $5 last year (as they will undoubtedly be again in the future), selling your car to buy a brand new Prius just didn’t make sense since the depreciation hit outweighed the fuel cost savings. We tend to focus on the costs that we see every day, such as gas prices and repair bills, but there often isn’t a lot we can do about them besides maybe driving less (and where’s the fun in that?). Depreciation is the bigger worry here.
The moral of the story? Buy used to save yourself from getting hit hard by depreciation, read this blog to learn more about how to buy the right car and keep its value as high as possible and stop worrying about fuel saving tips that will only make a 5% difference in your fuel costs (about 1% of the total cost of your car).
Here’s a spreadsheet I created to help you estimate your ownership costs and figure out what’s really costing you money. Yellow cells are for you to input, gray cells will be automatically populated.
Note: Insurance costs will expand or shrink based on how many miles you drive, so always update that with new information. The same with depreciation, but to a lesser extent since that is a function of both time and mileage. This worksheet is designed to illustrate the relative cost of different aspects of owning your vehicle, so if you’re an accountant and I have offended you by making approximations, count to 10 and stop hyperventilating.
Edmunds has a nifty tool called True Cost to Own that you should use when car shopping.
