Never Sell a Used Car

Yet another blog post from the personal finance mainstream that I must grudgingly acknowledge is good and useful. This one is on the advantages of driving a car until it is an inert pile of rust, rather than trading it in for something new. Get Rich Slowly guest blogger Joel Berry describes the financial benefits of driving a 1995 Geo Prizm, which has got to be just about the least impressive set of wheels imaginable.

That you should always buy cars used rather than new is a common and cliched bit of advice. Like many cliches, it is generally true. But I have always been amazed that the relatively obvious corollary, that you should never sell a used car, is rarely mentioned.

The crux of the matter is a bit of insanity that we all take for granted without reflection. New cars lose something like 25% of their value the moment they get an owner and continue to depreciate rapidly over the next year or two. Step back and think about this. The physical attributes of the car do not change when it is driven off the lot and generally do not deteriorate very much at all in the first years. So why does the market price for the car plummet?

There are basically two explanations. The first is that people are crazy. They will pay good money for the new car smell. Or they think that a newer car will attract members of the opposite sex. Much as I am biased in favor of any explanation based on the mental deficiencies of my follow man, I do not think this is all that is going on.

There is an inherent information asymmetry in the used car market. The owner of a car knows its true condition while the buyer does not. So the market price for a particular used car is based on the average value of similar cars for sale, not the specific value of the car in question. An owner considering selling a car will compare what he knows the car really to be worth to what he could get if he sold it. If it is worth more than the going rate, he holds on to it, if it is worth less, he sells. Which means that the used cars for sale tend to be the bad ones, which in turn reduces the average selling price, which means even fewer good cars are for sale, and so on. This is from a truly seminal paper published in 1970 called The Market for Lemons: Quality Uncertainty and the Market Mechanism.

On any rationally objective measure, used cars are cheap as compared to new ones. Moreover, and this is the point that most personal financial advisers miss, the average value of used cars that are for sale is far less than the average value of similar cars that are not for sale. So unless you have a real clunker, that car in your driveway is almost certainly worth more to you than you could get if you sold it.

It would be hard/impossible to get real numbers, but I am of the opinion that you take a bigger hit selling a used car than you do buying a new one, at least on a percentage basis. The optimal car strategy is to buy two- or three-year-old used cars and drive them until they are scrap metal. Which is what the experts recommend. But the real benefit is on the back end, not the bargain you get up front. Given the choice, and here is where I part company with the established wisdom, buying new and driving the thing until it stops running makes more sense than buying youngish used cars and selling them again when they are not so young.

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