The art and science of depreciation sounds pretty mundane and deadly boring, doesn’t it? Some numbers, something about time over money spent and a brand? Yeesh, let’s skip it. Right? Wrong. Depreciation is a crucial part of the car-buying equation and as both a buyer and seller you should understand how it impacts you and your bottom line.
First, let’s talk about what depreciation actually is. We put together a long list of terms you need to know when you go about buying a new or used car. Basically depreciation is the decrease of a vehicle’s value over time. That means that the longer you hold onto an asset, the more it drops in value. A car that you buy from the lot goes from new to used the second you sign the paperwork. That “scarlet letter,” if you will, impacts the value of the car negatively, regardless of whether you own it for 5 years or five minutes.
Depreciation happens for a number of reasons. First is the “stigma” or label that goes along with buying something that was previously owned by someone else. That stigma is largely psychological—just because someone owned something before you doesn’t mean that there’s anything wrong with it, we just know that we are not the first owners. In the car world, dealerships buy cars from a limited number of car manufacturers at wholesale prices. They then have to turn those cars around and sell them for a profit. After all, as we discussed in our piece on why cars at a dealership (even used ones) cost more, you’re paying for the salaries of the employees who work in the dealership, the cost of running the AC and heat, and even the lights in the place.
All of those costs are factored into the price of your new car. When the car rolls off the lot, the dealer no longer has control over how that car is treated, or what is done to it. Some people are great with their vehicles while others simply abuse them, and that has a big impact on the value of the car when it eventually returns to the market (whether in a dealer’s showroom or via a private seller). Dealers often inflate the price of a new car by anywhere from 5% to 20% over the invoice. There are all kinds of hidden things embedded in that sticker price so a good rule of thumb is to never pay that price.
Now that you have an idea of what depreciation is and where dealers make their money, it’s time to discuss why these awesome new machines take such a tremendous hit of depreciation when you drive them off the lot. We’ve touched on the psychological aspect of new versus used cars. Now let’s discuss the idea of the new model. Think about it this way. When a new iPhone comes out—are you willing to pay as much for the old iPhone? Of course not. It doesn’t have all the perceived bells and whistles as the new one, therefore it’s worth less. If a manufacturer puts out a new model that has more safety tech, or new things like Apple CarPlay and Android Auto, the perception is that that car is better, because it’s newer. It has all the things you “want” in your new car. That makes the price of the older model drop because (as is the law of supply and demand), the older car is less desirable than the newer car.
Here’s the kicker. New cars depreciate anywhere from 5% to 20% the moment you roll them off the lot. To illustrate this, let’s take a look at a luxury car priced at $50,000. If you buy a car for $50,000, it could be worth just $40,000 the moment you sign on the dotted line. That means that if you drove it off the lot, went a block with it and went back to sell it, it would only be worth $40,000. That’s a really big hit to take for just driving a block, right?
The truth is that cars in high demand will take a lower depreciation hit than those with a lower demand. According to Intellichoice, a company that analyzes data on every new vehicle sold in the US, in 2016, the vehicles that retained the most value (or took the smallest depreciation hit) were the Jeep Wrangler, Wrangler Unlimited and Porsche Cayenne. These rankings change from year-to-year so based on the model year you own, you could stand to lose more than those who own a newer model.
You should also recognize that popularity plays a large role in depreciation as well. Gas prices fluctuate over time. As gas prices go up, large SUVs go out of style and their values drop. As gas prices go down, however large SUVs become more desirable. As CarFax points out, what may be popular one year, may not the next and those vehicles that held their value could suddenly tank. Sadly, it’s all a matter of economics and group psychology.
So what can you do about it? Well, for one, the best way to ensure that your car holds its value is to take good care of it. Get the regularly scheduled maintenance done and keep your records of that maintenance up to date. Second, there’s an argument to be made for buying cars in more neutral colors like white, silver and black. Cars in those colors tend to their value better than others though you will see studies (like the recent one from iseecars.com) that argue that your next car should be orange, yellow, or green. We wouldn’t recommend choosing a car in those colors just for the sake of resale, though. It’s important that you enjoy your car first, so if yellow turns you off, don’t buy a yellow car. Overall the best way to protect yourself from depreciation if you are committed to buying a new car, is to buy something that you enjoy, and negotiate the best deal you can get at the dealership. The less you pay for a car, the less impact depreciation will have on your bottom line.
While new car depreciation sounds like a whole lot of accounting mumbo jumbo (and to some extent it is), it’s a hot topic even on sites like Quora. It can impact both buyers and sellers and it’s crucial to understand why depreciation is such a big deal no matter what side of the car-equation you are on.
For more on topics like this and all the ins-and-outs of buying or selling a car, check back here with us on Instamotor, on the regular.
Founder and a car nut. Born and raised from Detroit, Michigan. Val managed 12 dealerships prior to founding Instamotor.