Haven’t we all heard THAT before? Sometime it’s a flagrant excuse for an obviously wasteful purchase, but more often than not, this is a sincere sentiment. We think we are getting a wonderful deal as we whip out our credit card, thinking of all the reward points we’ll be earning.
But how do we REALLY know if something is cheap? Hint: It’s not simply the price tag. We actually need to think carefully about the purchase price as well as any additional costs that come with running, using, transporting, maintaining, fixing, insuring, feeding, storing, accessorizing, etc. whatever it is we’re buying over it’s useful life. What we need to figure out is the total cost of ownership.
An Imprecise Science
There’s no exact science to determine the precise cost of ownership for many things, as there are usually lots of uncontrolled variables that enter the mix. However, some basic back-of-the-envelope math is all that’s needed to get a good enough idea. This is especially true if we’re simply comparing different options in a new purchase, since in that case it’s the relative difference in cost of ownership that we care about.
So does the special $99 promo at the carrier for the new iPhone really mean that we’re getting the iPhone for half off? Before you say, “Wow, I’ll take two!” we need to look for the cost of ownership.
For starters, the phone actually costs $650 before carrier subsidies. But the total cost of ownership also involves the cost of a service plan, which currently is at least $1000 over the span of a typical 2-year contract for an individual on a low-tiered plan. So the cost of 2-year ownership for that “half off” iPhone is still at least $1000 plus the cost of the phone. No chump change for sure! For cellphones, the upfront cost of the phone matters much less than the cost of service. In this previous post, I break down a better alternative in which my family and I are getting smartphone plans with unlimited everything for only $20 a month, significantly cutting down the cost of ownership.
A full calculation of the total cost of ownership for a smartphone involves the following variables:
- Cost of the phone
- Cost of the service plan
- Cost of any additional insurance plan (i.e. Apple Care)
- Cost of accessories (i.e. Cases, screen protectors, bling)
- Potential cost of repairs
- Cost of the loss of interpersonal relationships with other humans by being overly attached to the phone (I’m joking…partly.)
And if you want to REALLY be geeky about it, you can even factor in the approximate cost of electricity to charge the phone. I think it’s negligible in the case of a smartphone, but certainly not in other purchases such as this next example.
Don’t Get Burned by Your Fridge
Imagine you’re shopping for a refrigerator and these are the two options being weighed: A $250 non-Energy Star fridge versus a $400 Energy Star fridge. Which one is actually “cheaper”? Let’s run the numbers to find out.
|Non-Energy Star Fridge||Energy Star Fridge|
|Cost of Electricity/Year||$90||$45|
|Cost of Electricity in 10 years with 3% annual rate increase||$1032||$516|
|Cost of Ownership in 10 years||$1282||$916|
So the difference over the course of ten years is approximately $366 in favor of the Energy Star Fridge. So put it another way, over the course of 10 years, the difference between the energy star model and the non-energy star one is nearly enough to purchase a second fridge. So which of the two is actually “cheaper”?
Obviously, the exact results will vary depending on your starting numbers and variables (electricity rates being different everywhere). However, the point is that it’s a notable difference when considered over the reasonable useful life of the appliance.
Now how about a more complex scenario?
The Total Cost of Ownership of a Car
When we look at cars, there are so many expenses associated with them that it’ll make your head spin. But this is perhaps also why we get duped so easily into paying for more than we need. Fortunately for us, Edmunds offers a nifty tool that can help us get a ballpark idea of the true cost to own a car. Again, these are based on their assumptions so don’t place too much weight on their absolute numbers, but this is very helpful when viewed relative to other cars you might be considering.
So here’s a comparison of the 5-year cost of ownership for a few vehicles using data pulled from the Edmunds TCO tool (I would have dredged up info on some older vehicles, but the tool doesn’t go back that far):
|2010 Toyota Prius (Used)||2014 Honda Accord (New)||2015 BMW 328i (New)||2014 Cadillac Escalade (New)|
|Taxes & Fees*||$1,388||$2,315||$3,914||$5,986|
|Total in 5 years****||$41,544||$60,899||$99,540||$148,006|
*Based on my area of Tennessee
**Based on 15,000 miles/year driven.
***This amount of car insurance seems really high, but we’re going with Edmund’s assumptions, so whatever.
****You’ll notice that on Edmund’s site, they also include a line for “Financing”, but since we don’t borrow money to buy cars, I’ve omitted that line from my calculations.
Obviously, this is a very small sampling of vehicles, but I think it’s effective to show just how much cars actually cost to own! Notice that even a used “efficient” vehicle like the 2010 Prius racks up a huge sum after 5 years of ownership. Did you see the line for depreciation? Not only is it the biggest cost, but it’s a phantom cost meaning it’s sucking you dry without you even opening your wallet! That’s why it’s far better to buy slightly used since the rate of depreciation slows with age. Needless to say, the cost of owning the new luxury vehicles on the right of the chart is downright mind-boggling. If you need a refresher on the Crumb Saver philosophy on cars, take a look at the previous post: Driving Off a Cliff with a New Car Loan.
The Tip of the Iceberg
I hope by now we see that the price tag on an item is only the tip of the iceberg when it comes to its true cost. The total cost of ownership takes into account everything else that’s under the water, and THAT’s the portion that can threaten to sink our personal finance ship! Whether you’re looking at houses, pets, tools, or toys, the lesson is the same, make sure you calculate the true amount of what that purchase is going to cost you.
What kind of other things are out there that behooves us to determine their total cost of ownership? What are some other factors that we should keep in mind as we make this determination?