Auto buying and financing thoughts from a Behavioral Economist, a Banker, and a Dad

Updated: Sep 17

Jeff Hulett, November 24, 2019

I think about auto lending along a couple of different roads. I’m an academically trained economist with a background in applied behavioral economics and consumer lending. Also, I have led lending organizations and lending-oriented consulting practices.

However, nothing motivates me more to think through the car buying process than my 4 kids and other people buying cars for the first time.

Below are car buying suggestions provided for my kids and to college students via personal finance presentations.

  • Why buy a car? Approaching car buying with the proper mindset and motivation is VERY important. Stick to objective car buying utility statements like “For safe transportation.” Try to avoid emotional or less objective statements like, “Because I like the technology,” “I like how it handles,” “I like how fast it goes,” “I like the color,” or “I like the smell.” Use your objective “why” statement as your decision beacon.

  • Consider ride share and public transportation as a viable economic substitute for car ownership. Do the math/business case. See appendix 1 for my experience with attitudes toward rideshare and car ownership. (Hint - Did you ever see the movie Braveheart?)

  • Assuming car ownership makes sense, your goal should be to minimize exposure to depreciating assets. Buying older cars helps reduce the depreciation risk. This occurs since the typical car depreciates quickly when it is newer and the depreciation curve flattens as the car ages. See appendix 2 for the typical depreciation curve and the market considerations for buying a car.

  • More specifically, your objective should be to buy a car to minimize “cost per remaining mile.” That is, determine a standard useful life, like 120k miles, you expect regardless of the car you buy. Then, look to buy a car minimizing the expected remaining mile cost. (Hint - use this calculation to compare cars: Total car cost / (standard useful life - current mileage), see appendix 3 for an example.

  • Buy cars with good maintenance records and that demonstrate a lower cost of ownership. This should include minimizing factory-provided car technology. Car tech is expensive to buy, expensive to maintain, and your smartphone with a car radio Bluetooth connection likely has much of the needed navigation. Plus, your smartphone is likely a more reliable technology server. Why pay for tech twice! Also, please see appendix 4 for how pollution can be considered when buying a car.

  • Before buying, always have a trusted mechanic inspect a used car. You will likely need to pay a small fee and it is worth every penny!

  • Pay cash for your car or endeavor to get as small a loan as possible, and especially, at as short a term as possible. As in the appendix 3 example, paying cash and using this approach to buying a car could save someone $2,200 per year and provide the equivalent of $500,000 for retirement.

  • Be proud of buying your car like an economist! The car buying road has many cognitive bias potholes. It is this economic awareness and discipline that will improve the quality of your life.

For more personal finance insight, see my 1-page overview, Investment Thoughts For My Children

Please see the attached excel file for our car buying workflow. This spreadsheet will help you through the process of buying a car, using many of this article's concepts.

Car buying workflow
Download XLSX • 98KB


1._Attitudes toward car ownership and ride-sharing:

As the former lead advisory recruiting partner at a Big 4 consulting firm and for a major university, I had the opportunity to interview many college students. As a core component of the interviews, I would typically provide a car economics-oriented case study. The case study goes something like this:

“Imagine you get a job in a major metropolitan area, you decide to live 10 miles from your office, and will commute daily. You have a choice of buying a car or using rideshare like Lyft or Uber. Take me through the business case to inform your decision as to the most economic transportation option.”

They then work through the case and compare the key cost categories and issues associated with each transportation option. As an interviewer, I’m judging the quality of their response, to understand how they structure business problems.

As a wrap-up question and as a curiosity, I ask the following question: “Assume now you get the data and calculate the case results. After working through the math, it is determined you are economically indifferent. That is, the cost of car ownership is the same as ride-share. Which transportation option would you choose and why?” I let them know there are no right or wrong answers.

Over time, the answers I have received are split down the middle. That is, about half the interviewees choose rideshare and the other half choose car ownership. However, the underlying reason is the same, and it relates to Freedom. I call it the Braveheart response. (after the Mel Gibson movie about fighting for Scottish freedom)

The car ownership crowd likes the freedom to drive whenever they want. The rideshare crowd likes freedom from the hassle of maintaining a car. Not too surprising, as freedom is a powerful motivator. Curious how everyone appreciates freedom but is split on how freedom is defined. Go Braveheart!

It would be interesting to learn how this attitude changes over a longer time period, especially as technology evolves.

2._Typical depreciation curve and market considerations for buying a car:

The “Here” on the graph is known as the inflection point. This is the point that value deceleration slows where value is decreasing at a decreasing rate. (Second derivative of the estimated curve is about 1). This is a good model vintage to consider buying.

Typical drivers of depreciation:

  • Actual wear - this also relates to maintenance costs, an expensive to maintain car will drop in value faster

  • The new car market - a strong new car market may depress demand for used cars

  • The used car market - this may relate to 1) seasonal, like the time of year new car trade-ins may enter the used car market or 2) cyclical, like when leasing residual and used car market imbalance may drive large lease cancellations and autos entering the used car market. Also, in a declining economic cycle, car loan repossessions may create an increase in used auto supply.

  • Salvage value market - may be driven by government programs like “Cash for Clunkers.” Think of salvage value as price support as the car ages.

In case interested, this is how the math works regarding the optimal model year:

The above depreciation curve has the following estimated functional shape formula:

y(hat) = f(x)= -.318 ln (x) + 1.0011

and simplified:

and the second derivative:

Upon solving the second derivative across the vintage years (x), the 5th car vintage year is closest to 1. So, target buying a car at least 5 years old to reduce depreciation risk.

3._Comparison example, purchase with cash or financing:

*Note: this is an actual example my son used to buy a used 2006 Kia Optima for $5,000. He bought it in 2016. As of this writing, the car is still serving him well!

4._Thoughts on pollution:

From a strictly economic standpoint, car pollution like carbon monoxide emissions is a negative externality. This means the economic activity of driving a car creates a cost to an unrelated third party. In this case, the third party is society at large. Pollution can also be considered in the economic context of the “Tragedy of the Commons.” According to The Economist,

“Today only 22% of the world’s greenhouse-gas emissions are covered by pricing schemes, and those schemes are not joining up”

In the case of the model presented in this article, costs fall under “Maintenance and lower cost of ownership.” Since pollution is not a direct cost, it is not overtly considered here. Good news though, pollution is indirectly considered in the “Remaining Miles” cost calculation and the “Safe Transportation” car buying utility statement. This occurs because, presumably, smaller cars and smaller engines provide safe transportation, have lower remaining mile costs, and are likely to pollute less. Notwithstanding The Economist’s comment, it would not surprise me if the future pollution-related cost of ownership becomes more of a direct cost “pricing scheme” through carbon taxes, low carbon emission tax incentives, and related cap and trade schemes.

Your Personal Finance Journey Guide:

Core Concepts

1. Our Brain Model

2. Curiosity Exploration - An evolutionary approach to lifelong learning

3. Changing Our Mind

4. Information curation in a world drowning in data noise

Making the money!

5. Career choices - They kept asking about what I wanted to do with my life, but what if I don't know? - Part 1

6. Career choices - They kept asking about what I wanted to do with my life, but what if I don't know? - Part 2

7. Career success - Success Pillars - Maximizing luck with an adaptable mindset to reach your goals!

8. Career choices - Do I need to be a Data Scientist in an AI-enabled world?

9. Career choices - Diamonds In The Rough - A perspective on making high impact college hires

Spending the money!

10. Budgeting - Budgeting like a stoic

11. Car Buying - Auto buying and financing thoughts from a Behavioral Economist, a Banker, and a Dad

12. College choice - The College Decision - Framework and tools for investing in your future

13. College choice - College Success!

14. College choice - How to make money in Student Lending

15. Event spending - Wedding and event planning guiding principle

Investing the money!

16. Investment thoughts for my children

17. Using the Stoic's Arbitrage to choose a great investment advisor

18. Anatomy of a "pump and dump" scheme

19. The Time Value of Money Benefits the Young

20. How Would You Short The Internet?

Pulling it together!

21. Capstone - The Stoic’s Arbitrage: A survival guide for modern consumer finance products

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