Should I buy a brand new car? - a strategic evaluation
This is one of the most popular decision questions to come into our course. And I don't blame them. With the cheapest car today (13 June 2014) being the Chery Fulwin 2 Sedan from China at $85,988, it is no wonder that we need to apply strategic thinking to answer, "Should I buy a brand new car?" (If you want to learn more about this process, please read this and then come back to this article.)
Before we go into the discussion, we need to set the stage to understand the industry:
The cars are priced including the Certificate of Entitlement (COE), which in effect is a right to ownership. So all owners need first to bid for the COE (current price is around $78,000) before they can get their car. The bidding is an open system, so if you have the money, you can get the COE. The COE is in limited quantity for each month. (At the COE price of $78,000, it puts the price of the Chery car at only $7,988!)
You can pay for your car in cash, or you may take a hire-purchase (loan).
Current loan rules require an upfront payment of at least 40% of the price of the car, and a maximum of 5 years of repayment. But for larger cars, the maximum loan quantum is 50% with the same tenure. We will use the 50%/5yr basis for our considerations.
Current loan rate is about 2.8% and for a $50,000 loan, the monthly repayment is $1,000. We will use this as a basis in our discussion.
So, with this, let us now discuss the question: "Should I buy a brand new car?"
There are myriad intents of owning a car and one cannot presume that in this case discussion it would be yours. But most people do articulate (whether truthfully or not) that their main intent is the convenience of moving around in Singapore.
With this, the options available are:
1. buy a new car
2. buy a second hand car
3. lease a car
4. move around in a taxi
5. join a limousine club
Thinking in time
1. There was a time when Singapore was not so crowded and taking the public transport was not too much of a hassle. But with the influx of foreign talent over the past 4-5 years, the public transport system has been taxed and may have gone pass tipping point. Until capacity can be increased, it is likely that the public transport system will be remain overcrowded, prone to breaking down and extremely inconvenient.
2. The limiting supply of COEs from 2012 has had a huge impact on COE price. When the LTA decided to limit the car growth, it caused COE prices to skyrocket. (See COE chart here). It is not likely that prices will come down to 2009 prices, unless another financial shock hits the system. Now that central banks are more cautious to bubbles and fluctuations, the likelihood will be slim. So unless the government allows for significantly more COEs on the road, or a large portion of the 2004 - 2007 cars are scrapped within the next couple of years, COE supply will likely remain tight, and hence the COE prices.
3. On a related note, the LTA increased the supply of COEs in April this year and the price of the COE dropped from more than $90,000 to just under $80,000 now. They predict that supply will increase further next year due to more deregulations, but it would be highly unlikely that COEs will hit 2009 prices. They may however come off another $8K to $10K. That would put the Chery Fulwin 2 Sedan at between $75K to $77K, still exhorbitant for a car that is valued at only $8000!
4. New vehicle loan rules were also recently put in place and it was thought that it would stabilise COE prices. Little did the authorities know that it had the opposite effect. One can suppose that this was to be expected because the demand curve for luxury goods is exceptional, and they curve backwards like a supply curve when the price gets too high. In other words, as price increases, so will demand! So this has the effect of pushing prices even higher, setting up a vicious cycle. So now we have the double whammy of exorbitant prices of COE and the lack of affordability of cars (it was previously 100% for 10 years!)
5. There has also been negative asset for cars with 9 or 10 year loans. This is because the loan quantum remaining towards the end of life (10 years) is more than the market value of the car. Hence, if the driver were to meet with an unfortunate accident due to no fault of his, he may still end up forking up huge sums of money when the insurance company decides it would not be economical to repair the car. The authorities are obviously concerned about this and will thus probably not return to 10-year loan tenures. This will keep downward pressure on affordability.
All these mean that, unless I have spare $50,000 cash or more sitting in my bank waiting to be spent on the downpayment, I might not really be able to buy a brand new car! (And frankly, for many people in Singapore who live on the edge each month, they don't have this kind of money)
Constraints & Assumptions
Everyone's situation is unique and their constraints may well not be these. But we conjecture some of the common constraints that people would have:
1. Monthly loan repayment does not exceed $1,000
2. Total monthly car expenditure does not exceed $1,800 (loan, gas, insurance, tax, parking)
3. To be able to go where I want to go with ease
4. Opportunity cost of money is low (at least minimised)
5. Greatest affordability
6. Does not impede on travel convenience
7. No adverse change in current lifestyle
1. Public transport will continue to be bad
2. Other forms of car use, e.g. leasing, is more expensive than purchasing
3. The vehicle ownership legistation does not change for the worse.
4. COE prices will be around $70,000 and above
Reframing for other options
1. Buying and renting out my car?
2. Getting a mini-bus + driver (which we can also hire out)
3. Joining a car co-op
Balancing options with constraints
Our constraints have limited a lot of our options, some of which are pretty good (like the mini-bus option if I were more entrepreneurial, or the limousine club if the hours of use are not so restrictive). We have come down to the following options:
Buying a used car
Leasing a car
We have already seen that buying a brand new car is out of the question because the opportunity cost of the downpayment of $50,000 or more (assuming I do have that kind of spare cash) is too high. The fact that repayment is over 5 years as opposed to 7 or 8, makes the affordability lower and causes me to front load my payment, thereby increase repayment amount. This therefore increases the opportunity cost of the money. Hence, we really cannot take this option.
This means that the options are either buying a second-hand car or leasing one. So now we need to identify what age of car we should choose when buying or leasing. To minimise opportunity cost, it should be 5 years or older so that I stretch my dollar. A 5 year old (2009) car puts it at the lowest COE value, which means that the car depreciation will also be the lowest, and hence, greatest affordability. So a 2009 car is the best option, provided we can find a good one that is well maintained.
Managing uncertainty with scenario thinking
When we put these two options into the scenarios, we realise that the leasing option is safer because of the age of the car. Since the lease includes all maintenance costs, it takes away the uncertainty of buying a used car. Also, the total amount of money spent over the next five years would almost be the same, with the leasing option just pipping the purchase option by about 20%. But we get to keep the downpayment which we would have had to pay up for the purchase. And that will allow us to put it to other good use (like investing) to make up the difference - and more!
So, based on our strategic evaluation, leasing a 5-year old car seems the best option. But of course this is for us. For you, with a different intent and different constraints, you might choose otherwise. But this is still good for your considerations, no?
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Written by Ian Dyason