I have created what I think is a formula for working out if it makes economic sense to buy an electric vehicle. You can find it below:
Explanation of the formula
The way to think about whether an EV is worth it or not is to consider the EV premium, which is the difference between the higher cost of the EV and the cheaper internal combustion engine (ICE) car. So for example, as of December 2023, the MG ZS EV costs $42,990 whereas the petrol version MG ZS is $21,990, so there is an EV premium of p = $21,000. When you pay for this EV premium, you are effectively putting this $21k into an investment that has a return () which needs to be compared to the return of other investments. For example, suppose you buy an EV and spend and extra $21k and from the fuel savings etc you make 3% per annum returns (). If you believe that an alternative investment such as DHHF or VDHG has an after-tax return of over 3% then you would be better off buying the petrol MG ZS and putting the EV premium of $21k into DHHF or VDHG.
Another key consideration is battery depreciation. The EV premium is mostly a battery premium. The investment you are making is mostly in the battery. This battery has a return that you get from having access to energy in the form of electricity. Energy in the form of electricity is much cheaper than from petroleum. However, the EV tax and battery depreciation needs to be considered as well.
Looking at the MG ZS vs the MG ZS EV, the fuel economy of the MG ZS is 7.1 L per 100km and the petrol price is assumed to be $1.75 per litre. This means that every 100km you drive you are spending $12.43 in petrol.
However, for the MG ZS EV, the energy efficiency is 17.1 KWh per 100km and the cost of electricity under the Powershop EV Plan is $0.18 per KWh, which means that every 100km you only pay $3.11 in electricity costs. However, add in the EV tax of $2.50 per 100km (only applies in Victoria, Australia) and battery depreciation of $4.29 per 100km assuming battery life of 350,000 km and battery replacement cost of $15,000 and the EV cost is $9.89 per 100km, which is still cheaper than the $12.43 per 100km from the petrol car.
Because costs depend on the distance you drive, whether it makes sense economically to drive an EV strongly depends on how much you drive. The more you drive (especially over 25,000 km per year) the more it makes sense to get an EV whereas if you drive under 25,000 per year, it starts to make more sense to drive a petrol car.
Something else to consider is that when you pay for petrol, you pay for it using after-tax money whereas if you put the EV premium into getting an electric car, the lower cost per 100km you get is tax free. You need to compare the return from paying the EV premium against the after-tax returns from an alternative investment e.g. the after-tax returns of DHHF or VDHG.
If we assume that you drive 25,000 km per year then the MG ZS EV costs $2,473 per year whereas the MG ZS costs $3,106 per year. Given the EV premium of $21k this means the return on the EV premium .
A major uncertainty is the battery depreciation as it is difficult to know the battery life and battery replacement cost. In fact, most of the costs of driving an electric car seems to come from battery depreciation alone.
Reddit comments
I shared this formula on Reddit and received mixed reviews. Some people raised very good points that I have missed in the formula, but I think overall the formula above is useful to know whether it makes sense financially to purchase an EV or not. Below are some other considerations:
EVs have lower servicing costs.
EVs are heavier and so tire costs are higher.
Charging from solar energy is ignored as this would add extra complication due to the capital costs of installing solar panels and/or home batteries. Charging using solar energy is not necessarily free as some claim as there is opportunity cost associated with locking capital up and not earning returns elsewhere such as DHHF or VDHG.
The EV tax in Australia currently only applies to Victorians. Laws may change in the future amending the EV tax.
Battery depreciation is considered but the depreciation of the ICE vehicles is not considered because it is assumed that depreciation for the EV and ICE vehicles are the same except for the additional EV battery depreciation. The assumption here is that when you buy an EV, you are buying something similar to an ICE car with a battery, so basically it is assumed that EV = ICE + Battery. However, the EV may depreciate more or less than the ICE vehicle depending on e.g. if governments increase or decrease EV taxes or subsidies. Some suggest that EVs depreciate faster than ICE vehicles, but this may change e.g. if the government introduces an additional carbon tax that applies to petroleum. If government is very aggressive in providing tax benefits for EV use, there is a risk that an ICE vehicle could become a stranded asset.
The formula above ignores power or acceleration differences between cars. The MG ZS EV is supposedly more powerful than the MG ZS. It is claimed that EVs are very quick to accelerate. However, this is ignored in the formula as we only want to focus on cost minimisation.
The formula ignores the environmental benefits of owning an EV as well as national security considerations (e.g. energy supply and price not being at the mercy of Russian or Saudi leaders).
The decision to get an EV or an ICE vehicle is very similar to whether you buy or rent a home. When you buy a home, you lock up a considerable amount of capital into the home. The benefit you get from living in your own home is that you don’t need to pay rent. If you buy your own home and then rent goes up significantly, you are better off. Similarly, when you buy an EV, you lock up capital because of the added cost of the batteries. However, the benefit you get from EV ownership is that you pay significantly lower energy costs. If you buy an EV and petrol prices go up, you are better off.
We also need to think about the future. Currently the break-even point is about 25,000 km. If you drive more than 25,000 km per year, it is highly likely you should buy an EV. However, if battery technology improves, petrol prices go up, and electricity prices go down, the break-even point will go down. There is also huge risk that an ICE vehicle you own may become a stranded asset if government policy aggressively addresses climate change. In my opinion, it is more likely that electricity prices will go down and petrol prices go up rather than the other way around. Electricity comes from multiple sources e.g. solar, wind, nuclear, and even gas, oil and coal. However, petrol only comes from oil. As such the supply of energy sources that can create electricity is much higher than the supply of energy sources than can create petrol, so higher supply should result in lower prices for electricity as an energy source.
Based on these considerations, in my view, even if you only drive 15,000 km to 20,000 km per year, if you’re in the market for a new car, it is better to buy an EV. It is better to drive an ICE vehicle if that is what you currently own and if you don’t drive too much (less than 25,000 km per year).
Rentvesting (a mix of renting and investing) involves renting a place to live while investing. When many people talk about rentvesting, they refer to renting and investing in property at the same time. However, another way to rentvest is to rent while investing in the stock market via ETFs.
When rentvesting into the stock market, it is better to leverage into the stock market i.e. borrow money to buy ETFs. An EY study into rentvesting into the stock market found that renting while leveraging into the ASX 200 index using a margin loan with 50% LVR was approximately equivalent to buying a place to live in. However, this study found that without leverage, it is better to buy a home. More leverage provides higher returns (and higher losses as well should the market go down).
Rather that using a margin loan, I recommend using NAB Equity Builder (NAB EB) instead because the interest rate on a NAB EB loan is much lower. As at the time of writing this, the NAB EB interest rate is 3.9 percent vs the CommSec margin loan interest rate of 5.5 percent. Many people criticise margin loans because of the dreaded “margin call” but if margin loan interest rates were equal to NAB EB interest rates, I would prefer a margin loan because it provides more flexibility on when to make repayments vs NAB EB which requires monthly repayments. A margin call is not as bad as many claim it is because it provides you with more flexibility on when you make repayments whereas regular monthly repayments do not provide as much flexibility because you are forced to pay monthly. However, this added flexibility has a cost i.e. a higher interest rate.
Another major disadvantage with NAB EB is that it is not an interest only loan and you are required to make principal repayments which are quite high considering the loan term is only 10 years. Property loans are typically for 30 years, which spreads out the principal repayments. Some property loans are also interest only. Margin loans provide the most flexibility by requiring no interest or principal repayments so long as the LVR is below a certain level. The consequence of these higher NAB EB principal payments is that the level of leverage achieved via NAB EB is lower compared to what could be achieved via a property loan or a margin loan.
An example
I have created a spreadsheet that details a typical example of someone who saves $130k deposit to buy a home and compared it to someone who instead puts that $130k into the VDHG ETF using NAB EB. After ten years, the person who uses that $130k deposit to buy a home has a net worth of $760k whereas the person who uses that $130k to leverage into VDHG has a net worth of $790k. What this shows is that by renting you are not throwing money down the drain. In fact, both option yield fairly similar net worth.
Renting and investing in VDHG via NAB Equity Builder is a good alternative to buying and living in a home
Let’s imagine you’re thinking of buying a $500k apartment, which means that you’d typically need a 20% deposit of $100k. Add in the stamp duty and it is about $130k deposit you would need in order to buy this property.
The alternative option is to put this $130k into NAB EB as a 35% deposit and buy $371k worth of VDHG. You might be wondering why the deposit amount is 35% and why VDHG is purchased. Basically you cannot achieve as much leverage with NAB EB as you can buying a property. When you buy a property, you have lower interest rates (2.69% compared to 3.90%) and you can borrow for 30 years vs NAB EB which only allows you to borrow for 10 years. The 35% deposit for NAB EB results in lower leverage (65% LVR vs 80% LVR for the property owner) but has similar cashflow. In other words, the property owner is paying $32k per year made up of $26k in mortage repayments, $5k in maintenance and $500 in council rates whereas the person renting also pays $32k per year made up of $38k in monthly debt repayments, $15k rent, -$15k in VDHG dividends (after PAYG tax), and -$5k in interest deductions.
What these numbers show is that the NAB EB disadvantage of high principal repayment is offset by the advantages that rentvesting provides i.e. you recieve dividend income and the ability to deduct interest expenses. The dividend income of $15k is after PAYG tax, which is assumed to be 37%. This dividend income covers the rent.
After ten years, the property owner sees his or her property worth $500k grow in price to about $1.06 million and has debt of $300k (calculated using a CBA mortgage calculator), which results in net worth of $760k. The renter sees his $371k of VDHG grow to $813k and has zero debt (as NAB EB loans are for 10 years). The renter has a higher net worth of $813k vs $760k for the property owner, but we need to consider the capital gains tax exemption that the property owner has, which means that the ETF owner pays $22k in CGT. The $22k in CGT takes into account the 50% CGT discount. The calculations also assume that the renter realises capital gains when he or she retires and therefore faces a lower marginal tax rate and draws down $40k per year in retirement. Because ETFs are more divisible than property, $40k per year can be sold, which reduces capital gains tax by spreading it across multiple years. After capital gains tax is considered, the renter has a net worth after 10 years of $790k vs the property owner’s $760k.
It is important to note that although renting comes out on top by a small margin, this analysis does not include measures that government often implement to entice first home buyers into the market e.g. recently there was an announcement by the Victorian government to reduce stamp duty by 50% for a limited time. These various incentives are not included in the analysis because they differ from state to state and typically do not last long. If these government incentives are included, the advantage for renters is likely to narrow or even disappear, but the main point of this analysis is that renting is not “dead money” and that you are not considerably disadvantaged by renting.
VDHG vs one property is not comparing apples to apples
One criticism of this anaysis is that the renter invests in VDHG, which is a broad and diversified high growth ETF provided by Vanguard that invests mostly in global equities whereas the property buyer buys one house. The property is not diversified and the price is estimated based on the price history of one Melbourne property on the BrickX platform (BRW01) that provided the highest returns (7.8% per year). In my opinion, this is more realistic as the property owner is buying one house to live in, and so the price history of one house should be used to estimate future returns.
However, comparing diversified stocks (VDHG) to undiversified property (BRW01) is arguably flawed. If we are to use undiversified property (BRW01) for our analysis, we have higher risk and therefore higher returns whereas the high diversification of VDHG reduces the risk and returns thereby putting the rentvester at a disadvantage. To compare apples to apples, we’d need to compare undiversified property (BRW01) to undiversified stocks, but then the question is which stock? If we choose Tesla stock then this returns 62% annualised. A renter who invests in Tesla stock undiversified would have achieved much higher returns compared to the home owner simply because his capital exposed to a very high growth asset. However, even though the renter is able to select good stocks, he or she may choose a bad stock that performs poorly. It makes sense then that we use VDHG, which diversifies across almost all stocks globally. However, we need to apply the same approach to property to compare apples to apples. If we remove the advantage of stock picking for the renter then we need to remove the advantage of property picking for the home owner. A home owner may pick a great property through research of public transport, schools, etc but the home owner may pick a bad property as well. In order to compare apples to apples, we need to diversify across all property across multiple countries. However, by doing this, the returns of property start to look very bad.
PWL Capital has considered this issue and looked at global diversified property vs global diversified shares: “To estimate this cost, we need to determine expected returns for both real estate and stocks. A good place to start is the historical data. The Credit Suisse Global Investment Returns Yearbook 2018 offers us data going back to 1900. From 1900–2017 the global real return for real estate (net of inflation) was 1.3%, while stocks returned 5.2% after inflation. If we assume 1.7% inflation, then we would be thinking about a 3% nominal return for real estate, and a 6.9% nominal return for global stocks.”
In other words, global property returns only 1.3% after inflation whereas global shares return 5.3% after inflation. This shows that the returns of property are very poor compared to shares. A property owner may argue that he is able to select good property in certain suburbs or cities, but the renter who invests in stocks could also make that argument that he is able to select stocks like Tesla, Amazon, or Afterpay.
Arguably, if you pick stocks e.g. Tesla or Afterpay (or even crypto such as bitcoin or ether), you are speculating whereas if you buy a diversified index fund such as VDHG or DHHF then you are investing. However, the same logic applies to property. If you select specific properties, which you must if you are looking for a place to live in, then you are speculating and not investing.
If you buy VDHG rather than select stocks, you reduce risk. You could have purchased APT but you also may have purchased a dud like Flight Centre (FLT). By investing in VDHG, you diversify and reduce risk. With the property you live in, there is no ability to mitigate risk. There is no VDHG equivalent for the property you live in because you are only buying one property in one location (unless you’re a billionaire who has multiple properties across multiple countries). As such, you don’t know if you will select a property in a suburb that does poorly due to e.g. zoning or if the property you buy may have existing cladding, termite or mould problems.
Once we compare apples to apples and compare diversified property to diversified shares, the renter is much better off than the buyer.
If you have higher income, consider more leverage with NAB EB
NAB allows LVR on VDHG of 75%, so leveraging with 65% LVR is well below the 75% limit. However, if a renter has high income, he or she is able to increase LVR. The table below shows ETFs where approved LVR is 80% which is the highest level of leverage. The highest LVR of 80% is allowed on global ethical ETFs (ETHI and HETH) and “old-style” Australian LICs (AFI and ARG). NAB EB also allows 80% LVR on a bond ETF (RGB) which in my opinion seems pointless.
NAB Equity Builder approved ETFs and associated LVR as of 21 November 2020 (Source: NAB website)
The age pension
One argument for owning a property you live in is that it is not considered as part of your assets in the asset test for eligibility for the Australian age pension.
However, if you own a liquid asset like ETFs then it is easy to simply sell that and buy a property in your own age if it is advantageous to do so. However, capital in the property you live in has an opportunity cost that may be greater than the pension you receive. Imagine you have a $1 million house and you get $24k pension per year from the government (which is the age pension payment for a single person as of January 2021).
Now let’s imagine instead that you put that $1 million in a high dividend ETF such as IHD and get $60k per year (IHD has a dividend yield as of January 2021 of about 6%). You’d pay income tax on this but that is offset with franking credits. You’d be able to rent that house for about $30k (rental yield is about 3% in Melbourne) and have 30k per year in spending money.
In both these cases, the home owner and renter are living in a $1 million house but the home owner gets $24k per year in age pension to live on whereas the renter is getting $30k in dividend income (after rent) to live on. The renter is slightly better off in this case.
Psychological considerations
The misconception that “rent money is dead money”comes from not perceiving opportunity cost. When you rent, there is a clear cost you are paying in the form of the rental payment made to the landlord. However, when you buy a home, there is an opportunity cost that is incurred because the capital locked up in the home could have earned a higher return. This capital could have earned an income if you don’t live in the property and instead rent it out and collect rental income, but the capital could also earn dividend income if invested in stocks. Furthermore, because there is no ability to diversify the property you live in, another cost is higher risk. Opportunity cost and risk are harder to perceive compared to cold hard rental payments.
There are also many psychological arguments home owners make in favour of home ownership which I think are valid. For example, a renter needs to move if the landlord forces him or her to do so whereas a home owner does not need to move because he or she owns the property. Furthermore, a home owner can do whatever they want to the property whereas the renter may need to ask permission before they e.g. put up solar panels. That being said, renters express control by selecting the property they want. If they want a property with solar panels, they can look for a property with solar panels and rent it. Furthermore, the renter, in selecting a property to rent, controls both the property and the neighbourhood surrounding the property. For example, if a renter lives in a neighbourhood they think has low crime, over time this neighbourhood may start to have high crime. A renter is able to move out to a better neighbourhood whereas a home owner will face $30k in real estate commissions to sell the property and another $30k in stamp duty to buy another property in a better neighbourhood. Chances are they will just stay in the neighbourhood and put up with the higher crime. This lack of control that owner occupiers have over the neighbourhood in which they live is the reason why we have the NIMBY phenomenon. The flexibility provided to renters to simply move if anything goes wrong arguably provides more control over both the property they live in and the neighbourhood in which they live, which is a psychological argument in favour of renting.
Further research
Ben Felix (PWL Capital) compares renting to buying. Note this video is geared towards Canadians rather than Australians.
Note: As of 21 November 2020, new applications for NAB Equity Builder are not being accepted due to high demand. You are able to fill in an expression of interest on their website if you’d like to be notified when applications are open.
I Live Off Dividends 