Tuesday, October 16, 2007

Accounting for a Car

I've been thinking some more about how to account for a car in net worth and spending following my discussion with commenters on this post. From an economic perspective we shouldn't really account for a car differently just because it was financed in a different way. Buying a car with cash means losing a say 5% return on the cash (i.e. risk free return) while buying using a loan means paying out 10% in interest say. The 5% and 10% are the opportunity costs of buying a car using cash or a loan. The loan is more expensive. But there is still a cost to using cash. If we treat the 10% interest as spending we should treat the lost 5% interest as spending too. So I propose accounting for a cash-bought car in the following way:

1. Put the current value of the car on the net worth balance sheet.

2. Calculate spending on the car (not including the actual cash expenditures on maintenance, insurance, taxes, and petrol etc.) as the interest on the outstanding value + the depreciation in the value that month.

This will have the effect of adding the lost interest to our measure of investment rate of return for the month. From the point of view of measuring investment performance it will be as if we still have that cash but spend the interest and some of the capital each month on transport.

For a car bought with a loan, in theory, you should only include interest on the loan and depreciation in your measure of spending each month. Principal repayments are saving, not spending (the same goes for buying a house on a mortgage).

A leased car is easiest - you can just count your lease payments as spending (ignoring the downpayment).

What do you think?


Anonymous said...

Well personally I wouldn't borrow to fund a depreciating asset like a car. Seems to me like interest and depreciation is adding insult to injury.

Having said that, I track my portfolio performance separately from my aggregate net worth. I track money moved in and out (mostly out these days) of my portfolio so that returns are more or less properly calculated. I used to do it on a daily basis but now I just do it once a month, close enough. Non-portfolio assets are to be minimized, at least on a net basis. I don't see the point in tracking non-portfolio net assets as a loan from portfolio assets. It is not exactly an arms length transaction, so it is just going to be a pro-forma number of no value in tracking investment performance.

If you want to beat yourself up about how much the car is costing, of course go ahead. But all you will do is make yourself feel bad.

In my opinion, you should change your goals to investment portfolio net asset goals, not net worth goals. At the end of the day, it is those assets which will be throwing off the income which you need to support your lifestyle. Everything else is consumption.

mOOm said...

Yes this makes sense. I'd feel worse though seeing net worth fall by that amount in one shot rather than spreading the cost out. And if we sold the car we'd then have to count it as income using the consumption all in one lump approach.

And economically speaking there's no reason to treat one method of finance different to the other. But for most people this is probably too complicated. Haven't decided what to do yet.

Adventures In Money Making said...

I just treat it as total loss of investment principle!

but getting to drive around in a great car is priceless!