Dave Ramsey‘s site has one of the best money hacks I’ve seen recently. Drive Free, Retire Rich explores the impact of carrying a car payment, and offers ideas on how your money can be used more wisely. Though the sentiment is familiar, I find Ramsey’s approach novel.
You want a brand-new sports car that would normally cost you $475 a month. The car you’re driving now is worth around $1,500. If you take that $475 and pay yourself instead of paying the dealer, you’ll have $4,750 in just ten months. Add that to the $1,500 you can get for your current car, and you can pay cash for a used $6,250 car. That’s a major upgrade in car in just ten months — without owing the bank a dime!
But let’s keep going. If you kept saving at that rate, you’d have another $4,750 in another ten months. Chances are, less than a year later, you could sell your $6,250 car for about what you paid for it. This means that you can step up again — with cash — into an excellent $11,000 used car just twenty months from today. Not bad!
Not bad, indeed. Ramsey goes on to explain how you could actually get “free” cars by investing your $475/month and using the returns to purchase your vehicles. (The assumed 12% return is a stretch, though the overall point is valid.)
How might I make this idea work for me?
- Instead of buying a new car from a dealer, I could set aside the amount I”m willing to spend on a monthly payment. The presentation uses $475/month as an example. I could never pay this much for a car. I’d be willing to go as high as $250/month.
- After a year, I’d have saved $3,000 for a car. According to kbb.com, the trade-in value on my current car is $3700. Using these two sources, I could buy a better used car for $6,700.
- Here’s where it gets interesting. If I kept making $250 payments to myself, I’d have another $3,000 saved at the end of the second year. Let’s say the $6,700 car lost another $1,000 in value and was now worth $5,700. I could trade it in and use my saved money to upgrade to an $8,700 used car.
- I can continue this cycle until I reach the level of car with which I’m comfortable. After that, the amount I need to save each year would decline sharply. I wouldn’t have to save to upgrade my car, simply to maintain the level of quality.
I’ll certainly remember this for the future. As soon as I’ve repaid my home equity loan — by March 2008 — I plan to begin saving for a car!
[Dave Ramsey: Drive Free, Retire Rich]
Note: I’ve never heard Ramsey speak before. Can anyone confirm whether that’s his voice in the presentation?