Total Cost of Ownership: Why is this Calculation Important?

By Hightower Westchester on March 30, 2020

As we move through life, making large purchases such as houses, cars and the like, become very important decisions that should not be taken lightly.  To shed some light on how to go about making these important decisions, we wanted to touch on the Total Cost of Ownership (“TCO”) calculation.   TCO is a calculation method that determines the overall cost of a product or service throughout its life cycle.  TCO aims to analyze the actual cost of purchasing a product or service from a given supplier, beyond the basic purchase price, taking a more holistic approach to assessing a purchase.  In a broad sense, TCO brings together all the costs associated with a particular product or service (acquiring, using, managing and withdrawing an asset) over its entire life cycle.  Not only considering direct costs, but also indirect costs.

Although generally a process more synonymous with supply chain management, TCO has made its way into many different sectors and thought processes.  Various models are available to calculate the TCO, depending on the product or service in question.  For example, the financial services industry.  Many mutual funds and similar products charge quarterly management fees and/or have withdrawal charges.  These indirect costs must be considered when calculating the true cost of these investments and something we analyze here at Hightower Westchester.

TCO generally includes the following key elements.  Each are applicable to different products and services:

• Purchase Price: cost price and supplier margin
• Operating Costs: initial training, operator/personnel, utility
• Cost of Ownership: stock management, depreciation costs
• Maintenance Costs: spare parts, maintenance
• Usage Costs: use value, operation, services
• Disposal Costs: recycling, resale, disposal

So now let’s talk about how to practically apply this method to your personal buying decisions. Let’s start with an automobile purchase example.  When calculating the total cost of owning a car, you want to start with your budget.  That budget will include – a car payment (if financing or leasing), insurance, gas, repairs and maintenance, registration, taxes and potentially a few other miscellaneous expenses.  All these factors are specific to an automobile purchase but apply to the TCO wheel above in one-way, shape or form.

Another important aspect to consider is that the TCO often changes over time.  Logically, your annual repair costs for an automobile will rise as it ages, as will the cost of servicing the car based on inflation.  Make sure you factor in expected changes in costs over the lifetime of the vehicle.

There are also calculators on the internet that can be helpful when going through this analysis.

Now, let’s examine buying a home, arguably the most important and costly transaction of your life.  I think it’s fair to say that we can all budget for the roof over our head when we are renting. ��Usually your monthly rent payment includes property repairs, taxes and, in some cases, even some or all your utilities.  On the other hand, estimating the true cost of home ownership isn’t quite as easy.  There are many expenses that are readily apparent but as we all know, home ownership comes with some unexpected expenses.

When breaking down your TCO for a home, you want to make sure you give yourself some cushion.  Yes, there will be fixed costs like your mortgage, Homeowners insurance, and you can likely get a ballpark figure on utilities, but when it comes to home maintenance, expect the unexpected.  Home appliances usually decide to stop working at the most inconvenient times.  Heating systems almost never die in the summer; they stop working on the coldest day in the winter.  And your plumbing somehow knows when you’re expecting house guests and chooses that as the opportune time to fail.

What’s worse than having repair issues?  Not having money to take care of the problem.  This is where having a plan around TCO for a home can make life a bit less stressful.  So how much will home maintenance cost?  There are two ways to go about ensuring you budget enough to cover repair costs: first you can budget 1 to 2% of your house’s value each year for home maintenance costs; or second, you can allocate $1 to $2 per square foot of your home per year. Which method you choose should be based on some basic research on the repair/replacement costs near where you live, as costs vary based on geographic location.  If you’re reading this thinking, “that’s a LOT of money to put aside every year”, just remember that you may not be using all of it each year, and with some repairs, once you make them, you won’t have to again for a few years.  When it comes to things like this, there’s comfort in knowing that you’ll have the money available to you if you should need it.

With that said, there is no one size fits all solution for determining TCO in all purchasing decisions.  For truly relevant solutions, it is much better to consider the specifics of each sector.

Knowing your TCO is a fiscally responsible way of looking at purchases throughout your life but it is only one piece of the pie.  Having an in-depth financial plan in place that includes all your assets, liabilities and goals is where you should be focusing your time first.  Once you have a holistic financial plan in place, you’ll have a better idea of what purchases will make sense for you and your family, both in the near and long-term.  At Hightower Westchester we have put together a financial planning questionnaire that can be very helpful when analyzing your budget.  Feel free to reach out to us for more information.

Richard Flahive – Private Wealth Advisor and Director of Research & Planning – Hightower Westchester

914.825.8639 – rflahive@hightoweradvisors.com