Saturday, October 22, 2016

When buying a hybrid car make sense

 I've recently received an email from the Toyota dealer where I bought my Prius from. The email states that it's due for its 80,000-mile scheduled maintenance.



I replaced my Honda Civic with a Toyota Prius C in 2012 hoping to save a ton of money because I have a long commute. My eldest son who was in college also needed a car at the time and my old Civic was the perfect car for him.

A Prius C is a subcompact version of the regular Prius. It was the most fuel-efficient hybrid car available in the market when I bought it, probably still is. It has a smaller battery and is supposedly more economical than a regular Prius when driving in the city.

I have driven to the moon

My workplace is approximately 40 miles away from where I live. So each and every working day, my car's mileage goes up by about 80 miles. I've been doing this commute since we purchased our home in 2004. Things like this happen when you love where you live and equally love where you work.

To put this in perspective, the miles that I've accumulated over the past dozen of years would have been more than enough for me to reach the moon!

vs

260 work days * 80 miles / work day * 12 years =
 249,600 miles

Is switching to a Prius worth it?

I've always wondered whether buying a Prius C is worth it as opposed to a relatively gas-friendly Honda Civic. I'm fully aware that this is not really an apple-to-apple comparison because I'm comparing two different car segments (compact Civic vs subcompact Prius). But am I better off buying a non-hybrid Civic instead, considering that it costs about $2000 less than the Prius?

Let's try and find out.

Obtaining historical gasoline prices

The first step is to research gasoline prices. So I went to gasbuddy.com to get the last 4- year historical information for my area:




From the above chart, I was able to obtain the average prices in the last four years. Notice the dramatic decrease in gasoline prices in 2015 and 2016 due to weaker global demand and increased supply, mostly due to OPEC members refusing to cut production pushing the supply to the highest levels.

Average gasoline prices and miles driven

Researching fuel efficiency of cars

My next step was to visit the fueleconomy.gov website to research the fuel efficiency of all the cars that we've owned throughout the years. There you can compare side-by-side the city/ highway or combined fuel consumption of the chosen vehicles.

The set of vehicles below is a very good selection because they happen  to represent 4 distinct markets according to size (sub-compact, compact, mid-size, and SUV).




Given the data that we have so far, I'm able to summarize the hypothetical cost of driving each vehicle for a total of 80,000 miles within the past 4 years in my area. For simplicity, we'll be using the combined MPG of the vehicles.


Gasoline savings matrix

From the above, I'm able to create a gasoline savings matrix that can easily tell me how much I would have saved (or not saved) when switching from a specific type of car to another. For example, this table tells me that I would have saved a whooping $8,684 when switching from a Honda Pilot to a Prius.


The same table tells me that I've already recouped the $2000 extra that I've paid for buying the hybrid because the resulting gas savings for driving the Prius in lieu of a Civic amounts to $3,256, which is substantially more than the premium.

Note that hybrids generally cost $4000 more than the non-hybrid counterpart. I've actually downgraded to a subcompact when I replaced my Civic with a Prius C.

Conclusion

Buying a hybrid made sense for me only because of my very long commute to work. Most people don't drive 20,000 miles in one year so it takes double or triple the amount of time for them to recoup their investment. Do not buy a hybrid car for the purpose of saving money on gas unless you plan to keep the car for a very long time.



Saturday, October 8, 2016

Projecting your future net worth

Yesterday, I was playfully googling my name maybe out of vanity and boredom. In doing so, I happened to bump into a comment that I wrote to a WordPress personal finance blogger in 2010.

The post reminded me of 3 things:
  1. my household net worth in April 2010 was $330,000
  2. my own mortality
  3. the responsibility to give back.
There is no doubt that I'm going to give away some of my wealth when I die. Not just for estate planning purposes (an estate worth roughly over $5 million dollars is taxed by Uncle Sam), but also for generously extending my legacy.

But what kind of wealth am I talking about? Is this the kind of wealth that will significantly benefit the community, or just my loved ones?  Would this wealth transcend generations potentially changing my family tree?

I really don't know. The most that I can do is to perform a very simple historical projection.

The first step is to determine the average rate my net worth grew for the known periods (i.e. average growth rate). The second step is to apply the same rate to the projected periods.

How to calculate the growth rate

The math involved is very simple.

Say, your net worth last year grew from $100,000 to $130,000. The growth rate for this period is calculated as ($130,000 - $100,000)/$100,000 = 30%.

Formula for calculating growth rate for a specific period:

(Ending net worth - Starting net worth)/ Starting net worth

You can obtain the average growth rate by applying the following formula:

(Growth rate in Period 1 + Growth rate in Period 2 + ... Growth rate in Period n) /
Number of Periods

Determine average growth rate

Here's what else I know, in addition to the number in 2010:
  • Our net worth was over $100K when we purchased our home in 2004
  • Current net worth as of this writing is somewhere around $975K
Running the numbers in Excel, the average growth rate that I came up with is 20%.



This chart shows that we have a net worth of around $328K in 2010. This closely resembles the number that I mentioned in the comment section of the Wordpress blog.

This also shows that my net worth grew by roughly $900,000 in the span of 12 years.

Apply the rate on projected periods

Of course, there are many factors that will affect our growth rate in the coming years, including:
  • Stock market returns
  • How fast my mortgage is paid off
  • Whether my kids go to a public or private university
As far as the first point is concerned, we certainly have no control over the price of MSFT, AAPL or GOOG stocks. But we certainly do have control over our spending.

Hopefully, our mortgage will be paid off in 2024 before the kids go to college. We also have $95K saved up for the kids' education.

If the great recession of 2008 did not stop us from having a 20% growth rate, I don't see any of these factors slowing us down.

Also, we love what we do. We both love our careers. I write financial web application software for a living and I see myself doing it until I retire.

All these considered, I've applied the same 20% growth rate. This is by no means a highly optimistic number.

Here's what the chart looks like for our last 15 working years:


The projected net worth when my wife and I both turn 60 is an astounding $15,000,000. At 3% inflation rate, this is equivalent to 10 million dollars in today's money.

In this chart, our net worth is projected to grow by 10 million dollars in the next dozen of years. Contrast this to the first chart where it grew by only $900,000 for the same length of time.

This phenomenon is referred to as the "power of compounding interest"- where the interest applied on top of the interest works exponentially in your favor.

Let's go much further than that and do a projection of our ending net worth, with the assumption that we both continue to live until the age of 90.

Applying a lower growth rate in retirement

Age 60 to 70 years

Here we stop working so growth rate is cut by half to 10%. But with 15 million dollars and no mortgage to pay off, we can afford to travel the world once every quarter. With this kind of money, the interest alone when invested at 5% is worth $750K annually. Our retirement income will be supplemented by dividends and rental properties that we will buy in cash. Half of our assets will be in fixed-income investments like bonds and CDs.  It is also in this period where my wife's pension will start to kick-in. Projected net worth is $42,000,000 by the end of this period. At 3% inflation rate, this is roughly equivalent to 20 million dollars in today's money. Thanks to a low-key lifestyle and continued allocation in stocks for the significant portion of our portfolio.

Age 70 to 80 years

Growth rate is cut by half to 5%. At this age bracket we probably will be less active. But hopefully we can continue to travel the world at least twice a year and enjoy other leisure activities. We will also start taking the required social security distributions maximizing the value. Majority of our portfolio will be in very conservative investments like bonds and CDs. I am also hopeful that by then interest rates will be higher. Projected net worth at the end of this period is $72,000,000. At 3% inflation rate, this is roughly equivalent to 25 million dollars in today's money.

Age 80 to 90 years 

Growth rate is -5% because this is the wealth reduction phase as we will start giving generously to various charities that we care about. We will continue to enjoy a good life not available to many. Health problems may kick in but this is hardly a financial concern when you have insurance and millions of dollars in the bank.


At the end of this period, our estate would still be worth roughly $48,000,000. This means that we have given away around 13 million dollars in today's money. Because at 2% growth rate, it would have grown to $91,000,000, if we weren't as charitable.

By then we would have already established a charitable trust that will distribute our assets to our heirs efficiently without the cost, delay, and publicity of probate court. There would still be over 12 million dollars in today's money to leave for my heirs to enjoy.

Instead of dying quietly, we will have the rare opportunity to greatly impact the lives of the people around us in a positive way.

It is in this phase that we will give like no one else in my family tree.

Only time can tell if my projection is right on the money.