Detailed Explanation
Depreciation is the loss of value in assets over time. Understanding it is relevant to personal finance because it affects your net worth calculations and purchasing considerations.
What Causes Depreciation
Physical Wear: Usage and age reduce condition and functionality.
Obsolescence: New technology makes old items less valuable (computers, phones).
Market Conditions: Supply, demand, and economic factors shift values.
Style Changes: Fashion and trends reduce appeal of older designs.
Appreciating vs. Depreciating Assets
| Appreciating | Depreciating |
|---|---|
| Real estate (usually) | Vehicles |
| Stocks & investments | Electronics |
| Businesses | Furniture |
| Some collectibles | Appliances |
| Land | Clothing |
Note: Some people consider this distinction when making purchasing decisions, as appreciating assets may contribute to wealth growth over time.
Examples
Vehicle Depreciation
| Age | Value | % Lost |
|---|---|---|
| New | $40,000 | 0% |
| 1 year | $32,000 | 20% |
| 3 years | $24,000 | 40% |
| 5 years | $18,000 | 55% |
| 10 years | $8,000 | 80% |
Example insight: A 2-3 year old car has typically already experienced the steepest depreciation.
Electronics Depreciation
| Item | New Price | Value After 3 Years |
|---|---|---|
| Laptop | $1,500 | $300 |
| Smartphone | $1,000 | $200 |
| TV | $800 | $200 |
Net Worth Impact
Wrong: Listing your car at purchase price ($35,000) Right: Listing your car at current value ($22,000)
Accurate depreciation accounting shows your true financial position.
Why It Matters
Understanding depreciation can inform various financial considerations:
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True Net Worth: Using current values instead of purchase prices gives accurate wealth picture.
-
New Purchase Depreciation: New cars often lose $5,000-10,000 in value when driven off the lot.
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Asset Considerations: Some people factor depreciation into decisions about asset purchases.
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Insurance Accuracy: Current replacement values are relevant for coverage decisions.
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Opportunity Cost: Some view funds in depreciating assets as potential alternatives to appreciating investments.
Updating depreciating asset values periodically can help maintain an accurate net worth calculation.