It seems to be a standard rite of passage for car owners. At about the 60,000km/3 year mark, your dealership sends a bunch of messages and emails to remind you that your service plan is about to expire. These are followed by enquiries about whether you’re considering doing a car trade-in. And then invitations to please come in and try the new Ford Focus.

At this point, the car-owner comes under a lot of pressure to deal with the dealership. Every interaction is peppered with disparaging looks and portentous warnings about your engine/brake discs*. And whenever you need something fixed or replaced: “Oh, well, you can try our sister-branch in <far-flung-rural-outpost-that-might-have-old-stock>; otherwise we’ll have to import that fan belt from Japan because the spares department no longer stocks it – should take four to six weeks.”
*Usually something about “outside the limits recommended by the manufacturer”.

And suddenly, you find yourself wandering around the showroom while you wait for the credit bureau to re-approve your financing.

And if you signed up for a balloon payment at the end of your financing period, then you can probably stop reading this post right here. Unless you’re willing to make that balloon payment…

Some preliminary notes on the incentives of car dealers

When it comes to acquiring and selling the big and more-complicated assets in our lives, we’re particularly vulnerable to manipulation. Estate agents and car dealers… There’s a reason that those two forms of employment are known for being predatory.

So before I get to the discussion of cost effectiveness, I have some observations to make:

1. No car salesman is going to be on your side. A car trade-in and new purchase is the salesfloor equivalent of a woman asking her husband if she looks fat in this dress. A wise husband will sketch together a loose array of factual assertions that allow him to interpret his own answer as “yes,” while allowing his wife the freedom to reasonably conclude that his answer was actually “no.” But she changes the dress anyway*.
   *An example: “Honey, you know you’re beautiful to me [Fact]. I’m just not so keen on the colour [Fact]. What about that blue one you wore to dinner last Tuesday [Suggested conclusion open to interpretation]?”
2. The reason for this: the car salesman earns a commission from his sale to you. Or he’ll have a sales target that he needs to reach. Or something along those lines.
3. The car dealership pays him a commission because they also really want you to make the deal. If you trade-in your vehicle, then the dealership gets a profit from the new car they sell you and interest on your financing. They will also earn a profit from re-selling your old car, and interest on the financing they offer the guy that buys it. Alongside a host of fun extras like motor plans and insurance kick-backs and such.
4. It’d be very… courageous of you to discount these incentives and believe that the dealer’s opinion is only marginally biased.
5. Especially when car dealerships set the timing of the car trade-in decision by giving you a three year motor plan… Or arranges a balloon payment at the expiry of your in-dealership financing.

But bearing those things in mind, let’s talk about the cost effectiveness of replacing your car.

The perception of car trade-in cost effectiveness

Obviously, when you’re considering a trade-in, you need to consider two factors:

1. The cost of replacement (ie. how much it costs to have a new car, less the trade-in value); and
2. The cost of continuing with your old one (repairs and maintenance, and so on).

If you believe the car salesman, the trade-in value of a car plummets immediately after your service plan expires. So the effective cost of replacement looks like this:

At the same time, the repairs cost gallops past the effective cost of replacement almost immediately. Thus:

And who knows how soon that will happen?

[This is normally where you start hearing stories about that guy last week whose engine exploded not long after he’d decided to pass on doing a trade-in]

So, obviously, you should upgrade as soon as you take your car in for its 3 year service.

The reality of car trade-in cost effectiveness

Truthfully, the plummet in trade-in value occurs as you buy the car, and actually slows as time goes on. Somehow, we manage to both know and forget this when it comes to trade-ins. And if I were cynical, I’d say that the three year mark is more likely to be the point where you’d be maximising profit for your dealer.

Also, your repairs cost does grow over time, but not immediately. From what I can tell, the real issues crop up at the 90,000 to 120,000 mile stage. That is: in the 140,000 to 190,000 km region. Which is a lot more than 60,000 km. And it makes sense – if the car company wants the benefit of being able to sell a car to a new-buyer market, and then re-sell the car again to the secondhand market – then you can hardly have the vehicle fall apart after three years.

But once you start replacing big ticket items, then I think you’re in trouble. After all, the more time your car spends getting repaired, the more irritating life becomes.

So in conclusion, there is a point at which you definitely want to get rid of your car:

And basically, you want to arrange your trade-in somewhere between when the dealership wants you to do it, and when your car is breaking down perpetually.

There is no rule of thumb for this decision. But you do get to calculate that point for yourself. Because every year, there is a little pocket guide released for the banks, insurers and second-hand car salesfolk, giving the replacement value of your make and model adjusted for mileage.

And when you start to see your repairs costs starting to creep up towards that vehicle value, it’s time.

Reasons to Trade-In Early Though

Prestige. Because it’s cool to have a new car every three years. That, or you have a balloon payment coming up. Or you don’t want the hassle of life outside of a motor plan.

Just so long as you know that you’re paying for it.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.