Financial decisions when buying a car
A car is among the costliest purchases most of us make in our lives, so making the right financial decisions is important:
Don’t take a loan.
Get third-party insurance.
Avoid insurance & dealer add-ons.
Buy a used car.
Consider a Maruti.
Wear a CFO hat.
Some of these may not be applicable to your situation1.
Don’t take a loan
This is the conversation I had:
Friend: I’m buying a 20-lakh rupee car, taking a loan for 15 lakhs.
Me: Taking a loan is not advisable. Why don’t you pay the entire 20 yourself?
Friend: I can’t afford 20.
Me: Can you afford 23?
Friend: Huh? If I can’t afford 20, how can I afford 23?
Me: That’s what you’re paying with interest!
Do you see how illogical my friend’s position is? It’s like saying, “I can’t lift 30 kg, so let me lift 40 kg.”
People who have unlimited wealth can afford to be wasteful: If Ambani buys a car, whether he chooses to take a loan won’t matter, because the interest is 0.0003% of his net worth. But for the rest of us, it does matter. Since we all have limited money, taking a loan drains away more of it. People take loans because they’re short-sighted: they think just about this year, not over the lifecycle of the loan.
Marketing tells us we’re entitled to a Creta. And we see our friends driving a Creta or a Seltos, so we want one too. We think we’re entitled to it, that it’s our birthright. In our capitalist society, where people are measured by their possessions, we may feel that not having a Creta means admitting we’re not successful. But we should decouple these. I’ll buy what I can afford today. And maybe tomorrow, I’ll be able to afford more, in which case I should buy it tomorrow and not today.
Buy only what you can afford.
Such timeless wisdom is lost in modern times, because of advertising and comparing ourselves with our peers.
Instead of buying a 20-lakh rupee car with a loan, consider instead buying a Wagon R for 9 lakh without a loan. Or a used car for 9 lakh.
Buy third-party insurance
There are two types of insurance:
Third-party insurance: If you get into an accident and you’re found to be at fault, your insurance company will pay the other party. This is legally required.
Comprehensive insurance also covers damage to your car2. This costs more, and isn’t required3.
Insurance has a negative expected value (EV).
What does that mean? Suppose I offer you a deal: pay me ₹10. Then we’ll roll a die. If 6 comes up, I pay you ₹50. Should you take this deal? To calculate this, consider both scenarios: you win ₹50 - 10 = ₹40, and you win -₹10. The former has a 1/6 chance of occuring and the latter, 5/6. So the EV is ₹40 * 1/6 - 10*5/6 which is -2. Since this isn’t positive, you shouldn’t take the deal I’ve offered you.
In general, don’t take any offer unless the EV is positive.
And insurance always has a negative expected value. In other words, if the insurance payout is ₹10 lakh and the chance of a payout is 1%, then the insurance company will charge you more than 10 lakh x 1% which is 10K. They might charge you ₹13K. The ₹3K goes to covering their overheads and making a profit. Self-insure. Pretend you’re own insurance company. Then you get to keep the 3K for yourself.
So, insurance always has a negative EV.
You should still take insurance when the loss is too high for you to afford, as with life and medical insurance. For example, I have medical insurance for ₹25 lakh a year. If I didn’t have it, I might have to shell out ₹25 lakh a year from my pocket, which I can’t afford. So medical insurance makes sense.
But comprehensive insurance for a car doesn’t. Imagine buying a car for 20 lakh. You read this advice and a voice in your head says, “If I take Kartick’s advice, but an accident happens and the car is totalled, I can’t afford to lose 20 lakh.” In that case, the solution is to buy a cheaper car, such as a 9-lakh rupee car. Unlike medical insurance, where it’s not your choice how much the treatment costs, this is very much within your control.
What did people do before insurance was a thing?
Don’t buy what you can’t afford to lose.
In the modern world, because of all the artificially generated noise, we’ve forgotten this basic wisdom.
I bought my Ritz in 2012. After a few years, I realised that if the car were totalled, I can easily afford to spend the < 5 lakh it would take to replace it. I switched to third-party insurance. This was so freeing! You should own your assets rather than the other way around. They should give you freedom, not obligations.
If I were to buy a car today, I feel I can afford to risk 9 lakh without buying comprehensive insurance. You might have a similar voice inside you. Listen to it. Your heart has already done a calculation as to how much you can spend and given you an answer. Don’t ignore it. The heart can’t explain or justify why, but that doesn’t mean you should ignore it. Decisions shouldn’t be made based 100% on logic. Feelings are subconscious logic.
If you were to spend more than you’re comfortable losing, you’ll feel weighed down rather than free. You could have buyer’s remorse that you overpaid4. That’s not how I want to feel. I want to feel that I’ve made a prudent decision.
This isn’t a permanent decision — you can always upgrade a few years later if your finances have improved. But you should:
Spend the money after you’ve earned it, not before.
Besides, I’ve had an insurance company cheat me by not answering the phone, telling me they’re working on it, etc — for months, till I gave up. And I’m sure your friends and relatives have had this experience as well. Insurance doesn’t eliminate the risk, just replaces one risk with another (the insurance company cheating you).
It’s not just the loss of money but the painful experience of dealing with insurance companies. Are you looking for more suffering in your life? I’m not.
Just buy third-party insurance from the cheapest provider.
Avoid insurance & dealer add-ons
When you buy a car, you’re offered various add-ons both from the dealer and the insurance company.
Let’s first talk about the dealer: don’t buy an extended warranty. Why?
It’s effectively insurance, and so has negative expected value, as I explained above.
It forces you to get your car serviced from authorised dealers. I’ve been cheated by Bimal Maruti, by being asked to get my car serviced even when it wasn’t necessary. And I doubt Maruti is the only trickster. So I wouldn’t want to lock myself into the authorised service network. In other words, I wouldn’t make a decision today that reduces the range of options available to me tomorrow, because I don’t have all the information today at the time of making the decision.
Now let’s consider insurance: When you buy insurance, you can buy various add-ons.
One of them is return-to-invoice (RTI). What does this do? Normally, if you have an accident and your car has to be written off, the insurance company will pay you less than what you paid for the car when it was new, since it has depreciated. If, however, you opt for RTI, they’ll reimburse you the amount on the invoice. That sounds good, right? Why wouldn’t you want a full reimbursement?
But the devil is in the details. RTI is offered only in the first 3 years of your car’s life, at which time the depreciated cost is close to the invoice value, anyway. You should be able to cover that difference from your side. Ideally, you should be able to cover the entire cost of the car if it’s totalled. But you should at least be able to cover the depreciation in the first 3 years. And if you can’t, that means that you’ve overextended yourself and you should consider buying a cheaper car.
Moving on from RTI, a second cover is zero-depreciation. This is different from RTI because it covers repairs to the car, not a total loss due to accident or theft. However, repairs cost far less than the price of the car, so you should be able to cover that yourself. Ideally, you should be able to cover the entire cost of the car if it’s totalled. But you should at least be able to cover repairs. And if you can’t, that means that you’ve overextended yourself and you should consider buying a cheaper car.
Avoid all insurance add-ons.
Buy a used car
There are a few reasons why you should buy a used car:
• Depreciation: Cars depreciate more in their first few years. In fact, they depreciate 20% the instant you drive them out of the showroom. If you buy a new car, you’re suffering this loss. If you buy a used car, you’ll get it cheaper.
Let’s take an example: assume that a new car will last you a decade. Instead, you buy a car that’s 3 years old. It still has 7 years left. In other words, it has 70% of its life still ahead. But you pay less than 70% of the price of the new car. So a used car gives you more than what you’d paying for. That’s where non-linear depreciation helps you. The first owner is taking a loss, so you’ll have a profit. If, on the other hand, depreciation were linear, where the car loses the same value every year, then buying a used car wouldn’t give you an advantage. Put differently, a car that costs 18 lakh when new quickly declines in value to 9 lakh (resulting in a loss for the first owner), and then slowly declines (resulting in a profit for the second owner). So you’re better off buying used at 9 than new at 18.
As an analogy, imagine your ISP gives you the option of 12 months internet for ₹10K or 7 months for ₹5K. You should obviously go for the latter, since you’re paying less than proportionally.
• Locked-up money: Does it make a difference whether you buy a used car for 10 lakh and sell it for 2 or a new car for 20 lakh and sell it for 12? In both cases, the loss is 8 lakh (10 - 2 = 20 - 12), but in the latter case, an additional 10 lakh of your money is locked up in the car. You’ll get it later, but you may need the money now. Or you could invest it somewhere to give you a profit. When you buy a used car, since it costs less, less of your money is blocked.
• Save insurance: Since a used car is cheaper, you can hopefully avoid a loan, buy third-party insurance and avoid add-ons, to save money. Sometimes saving money in step 1 opens the door to saving more in step 2.
• Upgrade to EV: Fossil-fuel powered cars are already obsolete, so if you’re buying one, you should invest less. That way, you’ll be able to upgrade to EVs sooner. If you were to buy a costly new car like a Creta today for 26, you’ll be stuck with it for a long time. Besides, fossil fuel cars will lose resale value as the market shifts to EVs.
• Better car for the budget: If you have a fixed budget, you’ll get a much better car for the money. For example, for a budget of 9 lakh, you can get a used Kiger over a new Wagon R, and I’d rather drive the former.
Consider a Maruti
Marutis have excellent resale value, so when you sell it, you’ll get back a lot of what you spent initially. For my 12-year-old Ritz, I was quoted a resale value of 50% of what I paid originally. So, consider a Maruti.
I’m not saying that you should buy a Maruti even if it’s cramped, or you dislike it, or if it doesn’t fit your needs. Not at all. Just that you should consider the resale as a factor in the assessment. It’s effectively a discount on the price. Think of a 10 lakh rupee Maruti as costing 9 lakh. So, if you’re choosing between it and another brand also priced at 10, ask yourself, “Would I buy the Maruti for 9 lakh or the other car for 10 lakh?” If you’d still buy the other one despite it being costlier, no problem, since you’ve considered all the factors.
Wear a CFO hat
When we buy something, we get carried away. The word “need” is the most overused word in the English language. I need want ventilated seats. I need want a panoramic sunroof. I need want an EV. It’s human nature to get tempted.
That’s why it’s important to approach a decision from multiple perspectives. One of them should be the finance perspective.
Companies hire a cold-hearted CFO to look at investments solely from the financial point of view. Similarly, if you’re a car enthusiast and your spouse isn’t, ask her how much is prudent to spend on a car. You need a dispassionate perspective. I mentioned to family friends that I’m considering buying a Creta for 26, and I got yelled at. When I asked my financial advisor, he told me that 15 would be a better amount to spend.
If nothing else, create a separate Notion page titled How Much Should I Spend on a Car? and write down a number there. In this page, don’t list features you want. Don’t even think about that. If you try to express two perspectives in one page, you’ll mix up both. A blank slate of a new page is important. If the number you’re written down in this page doesn’t work for the features you’ve listed in another page, don’t increase the number to make it match. Instead, embrace the contradiction. Over the next few weeks and months, think about whether you want to sacrifice features for price or the other way around. You need to be able to work on two incompatible perspectives independently for a while before picking one. Preemptively rejecting or watering down one leads to poor decisions. That’s why having two Notion pages to express each perspective without it being corrupted by the other is critical. Trying to do both in one page is like trying to drive a car in both forward and reverse at once — it doesn’t work.
Summary
Don’t take a loan.
Get third-party insurance.
Avoid insurance & dealer add-ons.
Buy a used car.
Consider a Maruti.
Wear a CFO hat.
Thanks to my financial advisor Vipin Khandelwal, Soumitra Sengupta and Pranav Shah for conversations leading to this clarity.
You can deviate as long as you can explain why it’s justified in your particular situation.
Whether by your own mistake or the other party’s.
In Bangalore, to register a new car, you need 1 year comprehensive insurance and 3 years third-party. After that, you can and should switch to third-party.
It’s possible to have buyer’s remorse in the other direction, too. You could end up feeling you could have bought a better car. But wouldn’t you rather feel proud of yourself for being financially prudent than the feeling of having poor discipline and decision-making?