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Why Do New Cars Depreciate So Fast?

Why do new cars depreciate so fast?

You’ve read the stories, and maybe you’ve even experienced the rapid depreciation that new cars get once they are driven off the lot.

Many people wonder why their cars depreciate so quickly at first, and we’re going to address some of the reasons below. Additionally, at the end of this article, we also discuss typical depreciation. So if you’re interested in why cars depreciate in general, then you’ll want to read that section.

To understand why new cars depreciate so quickly, you must first understand some fundamentals about the automotive industry and the types of car buyers.

Car dealerships mark up the price on cars

Duh- we all know that. These aren’t non-profit organizations. New car dealerships are an oligopoly, a cartel of their respective industry.  They sell vehicles from a select number of manufacturers, and the prices aren’t very competitive when comparing the same vehicle across multiple dealerships.  This is because the dealers purchase the cars from the manufacturers at wholesale and that price isn’t going to vary much.

The Suckers Price

The price you see in the window is the MSRP (Manufacturers Suggested Retail Price), also known as “the sucker’s price”. If you walk onto a lot and pay the price in the window, then you’ve joined a club that you probably don’t want to be apart of.

Never pay the price in the window.

The price of new cars are generally highly inflated. The price increase over invoice can often be between 5% to over 10%. It’s also worth noting that the invoice price includes profit for the manufacturer, and that’s where those “manufacturer rebate” deals come in. So there’s even more margin above the cost to manufacture the car that you can’t see in the image below.

Car MSRP chart

New Car Buyers VS. Used Car Buyers

There is a certain segment of people who buy new cars.  These are people who have been burnt by a used car, grew up only in new cars, doctors, lawyers, and other professions where image is important, etc.

Used buyers are people who either can’t afford new cars, or prefer to save money.  There are some circumstances that warrant a new car or a used car depending on your situation.  We’ve discussed these ideas in:

How much does a car depreciate when you drive it off the lot?

When driving a new car off the lot it basically depreciates by several thousands of dollars, and upwards of 15%-25% in the first year! This seems really drastic and illogical until you think about the reason. Once you sign the papers, your car goes from “new” to “used.” Congratulations, you’ve essentially just given your car a scarlet letter. We’ll explore this concept further below.

So Finally, Why Do Cars Depreciate So Quickly?

Now, finally we can discuss why rapid depreciation occurs.

The New Model Year Factor

In addition to the below, once a new model year of your car is introduced, anyone interested in a newish version of your car is now looking at the new model year. New functions, new features and new gadgets will help drastically reduce the value of your car once the new model year comes out. But let’s get  to the bigger reason: when a new car becomes “used.”

New cars become used cars

As we highlighted above, there are generally two types of buyers: new car buyers and used car buyers. When you drive a car off the lot it is no longer new and you have now narrowed the list of people who would buy it from you down to dealers and to used car buyers.  Here is the problem with those being your potential buyers:

  • Dealers will not pay more than they can get the vehicle for elsewhere.
  • Used car buyers will not pay the highly inflated price that you probably want for the car.

Here’s a picture I made to demonstrate the phenomenon:

New car prices vs used car prices chart

Those two things are the main reason why your new car is now worth 15%-20% (or more) less than it was 1000 miles or 1 year ago.  In essence, used car buyers let the new car buyers take the rapid depreciation hit on the chin for them, and this is why many millionaires will either buy a used car, or a low-priced new car where there is much lower initial depreciation.

Why Do Luxury Cars Like Maseratis, Cadillac, Mercedes and Jaguars Depreciate So Much?

It starts out for the same reason, but it is exacerbated by the giant profit margins these cars can command and one other factor that I’ll get to. Porsche and Bentley both make over $20,000 per vehicle; more than many people pay for their cars in total! The more luxurious the car, the higher the markup on it. But here’s another big issue: a smaller and more savvy resale market.

People who are looking for a used Maserati, Lexus and other luxury brands tend to be people who can already afford a new one. They’re just more frugal and trying to get a good deal. Additionally, this group of people is far smaller than the hordes of people searching for used Toyotas and Hondas. A small pool of frugal buyers just means a bigger price drop from the MSRP.

General Car Depreciation

Obviously, the above explanation is different from the actual reason that cars depreciate in general. The above simply accounts for the initial sharp drop in car value once you take it home and drive it around a bit. For those that are just wondering why cars depreciate in general, then here we go:

Why do cars depreciate?

Cars depreciate because they’re an asset that wears out over time. The same goes for the machines used in factories or the commercial grade mixer at your local bakery. As you use the vehicle, the probability of incurring costs in the future to maintain it increases and thus the value drops. Would you buy a car that needs a new engine for the same price as the same car brand new? Of course not, value has diminished. Depreciation helps account for that diminished value.

Cars will depreciate all the way down to the value of their raw materials (their metal primarily). That’s why a car that doesn’t function is still worth money. This is called its “scrap value.”

The moral to this story is, unless your job or image requires a new car, you should probably buy a good-looking used car that someone else lost all of that money on.

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