Now let’s spend a little bit of time talking about a few of the big financial decisions you’ll make in your lifetime.
Buying a car
The worst investment you’ll ever make
Cars have two important qualities that make them terrible investments. First, they are expensive, and second, they always depreciate, and do so rapidly. If this wasn’t bad enough, you usually need to take a loan out to buy a car so you’ll also pay a lot in interest for the right to lose money on your car.
Cars depreciate rapidly and especially so in the first couple of years of ownership. And people tend to keep cars for only a few years - when they depreciate the most. Because of this, it’s become much more common to lease cars instead of buying them. But that’s essentially the same as taking a loan out, buying a car, and then three years later giving up the car and canceling the loan. You aren’t any better off and in fact, it’s more like you are just renting a car three years at a time.
Whether leasing is better or worse than buying depends on both how long you plan to keep the car and how fast the car will depreciate. It’s not always easy to know the difference. I’ve usually bought cars and kept them for a longer time but when I did the math and considered the maintenance costs, I wasn’t really better off than had I been leasing so more recently I’ve tried leasing a couple of times. Now that interest rates are higher, leasing may not be as competitive, though.
While cars are a terrible investment, they are also necessary for most people. The US was built around mobility and the assumption that people can get to stores, schools, jobs, and other places by driving. There are some exceptions, like New York City and Boston, but for most of the country, it’s difficult to get by day to day without a car.
In your lifetime, you may see ride-sharing services and self-driving cars become mainstream enough that you don’t need to own a car yourself. But we aren’t quite there yet.
Since cars are such a bad investment, the best you can do to minimize the impact is to buy an affordable, good-quality car like a Kia or a Honda. If you know you are going to lose 20% of your “investment” going in, it’s better to buy a $20,000 Kia than a $80,000 BMW.
Buying a house
The best investment you’ll ever make?
Buying a home is the single largest purchase most people will make in their lives. For a number of reasons, it often works out to be the best investment people ever make, even though real-estate returns are not really that great historically. The reasons are:
- Real estate is usually a long-term investment. The median time people stay in their home is 7.5 years and later in life, many people will stay in their home for decades. As we saw with compound growth, even at a small annual growth rate, time is your friend and can lead to significant long-term appreciation.
- People usually buy a home with a mortgage giving them leverage. Leverage in investing gives you exposure to a large investment with a smaller amount of money upfront. Most banks suggest putting a 20% down payment on a house before they feel comfortable loaning money to a person, so that translates into 5x leverage. That is, to buy a $500,000 home, you’d need to put down $100,000 and borrow the additional $400,000. But if your home’s value increases by 20% over 5 years and is now worth $600,000, your gain is $100,000 on a $100,000 initial investment or a 100% gain (5 x 20%). That’s the leveraging factor at work.
There are some details I’m glossing over here such as the interest on your mortgage, the amount you’ve paid down on the loan, and the cost of maintaining your home, but ignoring those details, the key points hold.
Now just because a home ends up being the best investment many people make in their lives, it doesn’t mean it actually is a great investment. You’d still probably be better off investing in the stock market over the long term but my guess is that most people never invest as much money in the stock market as they do in their home so they just don’t experience that potential better outcome.
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The process of buying a home is similar to buying a car, but the scale is much larger and the process is more complicated. You’ll usually put a down payment on the house (say 10%-20% of the price of the house but sometimes as little as 5%) and then borrow the rest from a bank. Because home loans are so much larger, their term is typically much longer. Most people in the US have 30-year mortgages.
As mentioned, people will usually move before paying off their old house so when they do, they will coordinate the sale of their old home and the purchase of their new home at the same time. Hopefully, they will sell the old home at a profit and use the proceeds to pay off the balance of the mortgage and then keep the rest, or apply it to the purchase of the new home.
Getting married
(And starting a family)
The other two big life decisions that have significant financial implications are getting married and starting a family. While these are separate issues, the first often leads to the second, so I’ve put them together.
Getting married isn’t a financial decision in itself (although for some people it may be), but it can have a big financial impact. When you get married and start living with someone, assuming you are both working at that time, you get a lot of financial benefits just by pooling your resources and sharing your expenses. Paying one rent bill or mortgage rather than two, is usually much cheaper, as well as all the other expenses in life like utilities, groceries, health care, vacations, and more. There are also legal and tax benefits to being married.
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At some point, if you decide to have children, you’ll embark on a life-long journey that has many benefits and rewards. That said, it’s expensive to have and raise kids.
First, there are significant medical costs throughout pregnancy and in a child’s early years. You may want to move to a more expensive location to have access to better schools. You’ll need a bigger house or apartment for your growing family. You may need an additional car. If both of you decide to continue to work, you may need to hire a nanny to give you the flexibility to be out of the house during the day. If one of you decides to step back from work to be a primary caregiver, then you’ll need to get by on less income.
Having children is not a financial decision, but it has financial implications so it’s good to be aware of these issues and to consider them so you go into it with your eyes wide open.
“It is good to have money and the things that money can buy, but it’s good too, to check up once in a while and make sure you haven’t lost the things money can’t buy.”
A final thought on this whole topic: Money isn’t the most important thing in life, but learning how to manage it capably and responsibly can give you the financial freedom to enjoy the things that really are important to you.