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Extended Warranties

There are a couple stores around here that push their extended warranties ridiculously hard. Sports Authority is probably one of the worst. No matter how I say “No”, I continue to get the guilt trip throughout the entire transaction. It almost makes me want to explain why I never buy it, but I question whether they’d understand the math. Here’s how it works out:

The break even price of a warranty is equal to the cost of replacing the item times the percentage chance that you’ll need to replace the item. So if the product costs $100 and there’s a 20% chance that it will break, then you should buy the warranty if it’s less than $20. The trick is that it’s usually impossible to define the odds that you’ll need a warranty. There’s still a way to prove that it’s a bad deal though.

Think about the company offering the warranty to you. If they charge everyone less than that breakeven point, they’re going to go out of business. They need to make a profit so the warranty is almost ALWAYS going to cost more than that breakeven point. Therefore it’s a bad financial deal for you to buy it.

There are, however, some cases where warranties and insurance are a good thing. Those cases are generally when you do not have enough financial reserve to cover the replacement cost if the item is destroyed. Think about your house or your car. If you have $30K lying around to buy a new car, then you could technically get buy without insurance (though they’ve made insurance a legal requirement since almost no one has this kind of reserve available.)

So when you’re standing at the register and they offer you the extended warranty, know that it’s a bad deal and if you can envision paying that much money again to replace the product, do not buy the warranty. You’ll come out ahead in the long run even if you do have to pay full replacementreplacmenet value every once in a while.