Is an extended warranty worth it? An extended warranty is a form of insurance, and those who sell insurance make their money on the fact they collect more money than they pay out in claims. Therefore at face value, purchasing an extended warranty (or any form of insurance) is statistically not profitable.
The Law of Large Numbers
However, these calculations are based on the statistical smoothing out that comes with large numbers. If you purchase thousands of cellphones, not purchasing the extended warranty is the better move. All the money you save not purchasing the extended warranties, can then be used for the rare cases where you do need to purchase a replacement cellphone. In this case, you are acting like your own insurance company. By going through life and not purchasing extended warranties across lots of items, you gain some of the statistical confidence that comes with large numbers. Even if I do need to replace my cellphone, the money I’ve saved by not buying extended warranties (on it, my tv, my laptop, my camera, etc.) is enough that overall I’m still coming out ahead.
When Does Insuring an Item Make Sense?
My own personal guideline is if replacing the item twice would have a severe impact on my finances, then I should insure it (which can be in the form of an insurance policy or something like an extended warranty).
I bought my Sonicare toothbrush at $70 and I’m fortunate enough that if I had to replace it twice ($140), I’d be grumpy but it would not have a severe impact on my finances. no insurance
If I went out and bought a brand new car for $30,000 (sidenote: I’ve never owned a brand new car), replacing that twice ($60,000) would have a severe impact on my finances. insurance.
If my wife and I had to purchase our house again twice*, it would have a crippling impact on our finances. insurance
* Since we have a mortgage, we haven’t finished paying it off once yet.
Risk and Cash Flow
Risk tolerance and cash flow vary for each person so where the exact line is for each person is going to vary but my guideline
If I had to replace this item twice, would it have a severe impact on my finances?
has served me well in deciding whether or not to insure (a.k.a. purchase an extended warranty on) an item.