Interest-ing

From Dave Ramsey's Financial Peace Planner:

Now let's move to a bigger ticket item--the family car. Car payments can be the biggest waste of money! Who wouldn't love to drive paid-for cars for the rest of his life? The power of compounding interest can help.

J. G. and Jill bought a used car for $4,100 cash. Even though they won't need another car for a while, they decide to start saving for the next one right away. So they put $200 a month into a mutual fund at 10 percent interest. By year seven, they will likely need a new car, but will be ready. Their savings will have grown to approximately $24,190. Now they can buy a new $16,000 car, have no monthly payments, and still have $8,190 in the bank.

After buying this new car, J. G. and Jill decide to continue saving for the next car, but they cut back their monthly payment to $100. At the end of seven more years, that $8,190 left over plus the $100-per-month investment grows to $28,540. Again, they have a seven-year-old car they want to dump for a new one. So they buy yet another $16,000 car for cash, leaving $12,539 in savings. For another seven years, they have no car payment, but they quit saving. Even so, the $12,540 at 10 percent will grow to $25,179.

The bottom line: By sacrificing with a lesser purchase up front and saving the difference, J. G. and Jill can drive paid-for cars and have savings the rest of their lives. That is compound interest working for you.