While taking part in Dave Ramsey's “Financial Peace University”, we heard a great example of how you could turn traditional thinking around, and make your money work for you.
Drive Free Cars For Life!
They started the lesson out by talking about how the average new car payment for 1/3 of car buyers is $475 with a loan term of 6 years (for a $26,000 car with 9.6% interest). Most people will just assume that they will always have a car payment, and that having a car loan and payment is just a part of life. It's something that you can never get away from!
According to Dave Ramsey, if you turn that thinking around, within that first six years you can get to the point where you'll never have a car payment again!
How To Never Have A Car Payment Again
Let's say the car you're driving now is worth $1500, and instead of paying a dealer $475/month for a new car like most people do, you save that money for 10 months. At the end of 10 months you'll have $4750, along with another $1500 from the sale of your old car. With that money you can buy a new car worth $6250.
If you keep going along those lines for another 10 months, you'll have another $4750. At the same time you'll probably be able to sell your new $6250 car for just about what you paid for it. That means you'll have $11,000 to spend on another new car, just 20 months after you started with a $1500 car!
Let's say you decide to keep that new $11,000 car for the full six years it would have taken to pay off a new car with a loan. Continue paying yourself that $475 payment every month for the remaining 52 months, and put it into a good mutual fund. If you receive a return of 12%, then you'll be sitting on over $32,000 dollars after the 6 years is up. Even if you receive a smaller return than that (likely in this environment), you'll still have quite a bit more saved up than when you started – and no car payments!
Free Cars For Life: Wash Rinse Repeat
If you go now and buy a nice used car for $12,000, you'll still have 20 grand sitting in your “car replacement fund”. If that fund continues gaining 12%, even if you never add more money to the fund, you'll be able to buy $14,000-18,000 cars every 5 years from now on! The interest you're gaining in that account will pay for your new cars for the rest of your life!
How do I retire rich?
Here's the fun part. Once you've established your car replacement fund, from then on you'll be ok to take that $475 you would have used to pay for your new car loan, and invest it in a mutual fund. If you gain 12% interest, here's how the numbers work out if you invest that amount for 10, 20, 30 and even 40 years:
- 10 years – $100,000
- 20 years – $470,000
- 30 years – $1,600,000
- 40 years – $5,588,385
So there you go, Dave Ramsey's plan to drive free cars and retire rich.
While it does depend upon you earning a good amount of interest through your mutual fund (and make some assumptions about a pretty high rate of interest), as well as some other assumptions about car values, it doesn't sound impossible to me. I know we would never pay $475/month for a car, but at the same time this example really brings home the idea that the returns of compounding interest are something we all need to strive towards gaining.
Let me know what you think about this plan in the comments!