The 1/10th Rule For Car Buying Everyone Must Follow

Old Car In EstoniaAfter introducing the 1/10th rule for car buying in 2009, some people changed the way they went about purchasing a car. Meanwhile, many more complained my rule was too onerous for the typical income earner.

I watched in horror as a total of 690,000 new vehicles averaging $24,000 each were sold under the Cash For Clunkers program in 2009. The government’s $4,000 rebate for trading in your car ended up hurting hundred of thousands of people’s finances instead! Your $20,000 invested in 2009 in the S&P 500 index would now be worth over $45,000!

Buying too much car is one of the easiest and biggest financial mistakes someone can make. Besides the purchase price of a car, you’ve got to also pay car insurance, maintenance, parking tickets, and traffic tickets. When you add everything up, I’m pretty sure you’ll be shocked at how much it really costs to own a car and barf!

The 1/10th rule for car buying is simple. Spend no more than 1/10th your gross annual income on the purchase price of a car. If you make the median per capita income of ~$42,000 a year, limit your vehicle purchase price to $4,200 if you must buy one. Absolutely do not go and spend the median car price of $24,000!

A median income earner buying the median priced car is financially absurd. Who spends 60% of their gross salary on the purchase price of a car? Worse yet, who spends 75% of their net income after 20% taxes on a car?

WHY YOU SHOULDN’T SPEND MORE THAN 10% OF GROSS ON A CAR

1) Maintenance costs: We’ve got auto insurance, maintenance, parking tickets, and traffic tickets. Furthermore, the thrill of owning a new or new used car lasts for only several months, but the pain of paying the same car payment lasts for years.

2) Opportunity cost. When you buy a car you lose the opportunity of investing your money in assets that will likely grow and pay you dividends in the future. Everybody knows to save early and often to allow for the effects of compounding. Buying too much car is like negative compounding! Imagine how much money you would have accumulated if you invested $300-$500 a month in the stock market over the past three years instead of paying for a car? Probably around $15,000-$30,000!

3) Stress. When you pay more than 1/10th your income for a car, you will become more stressed. The stress you feel from not wanting to park your car in a crowded lot is completely because you cannot afford your car! If you are within 1/10th of your income, you drive and park stress free. You stop caring about door dings, bumper scrapes, even break ins. Stress kills folks.

4) Makes you want more. The nicer your car, the nicer your other things. You start thinking stupid thoughts like: I’ve got to buy a matching chronometer watch, driving shoes, and outfit. You start paying $20 for valet because you want people to see you come out of your car instead of park for free. Having nice things makes you want to have nice everything!

5) Makes you feel stupid. Deep down, you know that if you can’t pay cash for your car and have money left over, you can’t afford the car. Each payment you make is a reminder how foolish you are with your money. Why would you want to be reminded every single month of being dumb?

IF YOU’VE ALREADY MADE THE MISTAKE

Look, everybody makes dumb financial moves all the time. The important thing is to recognize your mistake, stop, and fix it! Here are some things you can do if you’ve bought too much car already.

1) Own your car until it becomes worth 10% of your income or less. This is the simplest solution if you’ve spent too much. Drive your car for as long as possible until the market value is worth less than 10% of your gross annual income.

2) Bite the bullet and sell your car. If you’ve spent anything more than 1/5th your gross annual income on a car, I’d sell it. It’s making you poor. Even if you have to take a little bit of a hit, I think it’s worth getting rid of your vehicle. Don’t trade it into the dealer because you’ll get railroaded. Instead, try negotiating via Craigslist.

3) Punish yourself. If you don’t punish yourself, then you will repeat your mistake and feel fine with what you have now. For the life of your car loan, take away a food you love to eat such as chocolate. If you are a coffee addict, swear never to drink that stuff again! Save more of your income after taxes and feel the squeeze so that you realize how ridiculous your car spending is.

RECOMMENDED CARS BY INCOME (TASTES MAY DIFFER) 

1/10th Rule For Car Buying Chart

Cars built in the 1990’s and beyond are so much more reliable than those built prior. If you are serious about improving your finances, consider buying a car with less options, and less electronics to deal with. The more you have loaded in your car, the more maintenance headaches you will have in the future.

Financial Status Based On Your Car Spending Habit Chart

THE CHOICE IS YOURS

Treat the 1/10th rule of car buying like a game. You will be surprised to find how many different type of cars you can buy with 1/10th your income if you make over $25,000 a year.

If you want a $30,000 car, get motivated by the 1/10th rule to figure out a way to make $300,000 a year. If you can’t get motivated, then fine. Just don’t think you can afford much more. Think about your future and the future of your family. A car is simply there to take you reliably from point A to point B. If you’re thinking about prestige and impressing others, don’t be silly. Owning a nice property is way more impressive because at least you can potentially make some money from the asset!

One of the worst combos is owning a car that you purchased for much more than 1/10th your gross income and renting. You now have two of your largest expenses sucking money away from you every single month. Think about all the wealthy people you know, or the millionaires next door. Chances are, the majority of them own their homes and drive used cars that don’t come close to 50% of their gross income.

If you want to achieve financial independence and not have to worry about material things stressing you out, follow my rule. If you want to detonate your finances and end up working longer than you want for the sake of a nicer ride, then go spend more than you can afford. One life to live right? All is good!

Recommendations To Protect And Grow Your Wealth

Check for lower insurance rates. Auto insurance is the second biggest expense to owning your car. Esurance is the leading online market place to help you find the most affordable and reliable auto insurance. They get you comparison quotes to make sure you’re getting the best deal. You can easily purchase auto insurance straight from their website if you like what you see. It is very important that everyone gets at least basic liability car insurance. You can total your car and be fine. But if you total someone else’s car and injure them, they can go after you for ALL your assets and wipe you out! Check for a better auto insurance quote via Esurance today.

Sign up for Uber and get a free ride. Uber is one of the cheapest and most convenient ways to get around town. They are much cheaper than a taxi (~30% less) and much more reliable because you hail them through an app and can track their progress. There’s never any cash or tip to pay since everything is linked to your Uber account. Furthermore, you won’t get any more parking and traffic tickets either. If you sign up for Uber, you get your first ride up to $30 for free!

Manage Your Finances In One Place: The best way to become financially independent is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing and how my net worth is progressing. I can also see how much I’m spending every month. An excellent feature is their 401k Fee Analyzer which highlighted $1,700 a year in fees I had no idea I was paying. There is no better financial tool online that has helped me more to achieve financial freedom.

Updated: 9/14/14

Best,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Bains says

    I was about to buy a used BMW xdrive 535 for about 35k but i accidentally read your article(the night before going to the dealer) and followed your advice and instead bought a used accord for 16k and the remaining money is sitting pretty in my 401k.
    -Thanks

      • DemandSider says

        If you are in Minnesota, put a max price of $2000 to $5000 dollars in to “cars and trucks” search in Craigslist. Find a car below 70,000 miles with little to no rust and some kind of fuel injection. If you find something older that is carbureted but is almost mint (you will find one), make sure you know how to start it in all weather. Older people drive Crown Vics, Caprices, Continentals, Acclaims, Shadows, Spirits, etc., and they tend to put few miles on their cars and baby them. Do the math on your annual mileage and fuel use to see if a low mileage yet safe V6 or V8 is feasible. Foreign cars tend to be way too expensive for the mileage.

  2. Shyam says

    While i think that many of FS’s nuggets of wisdom are right, I think this car rule thing, especially buying the used car suggestion is ‘soul deadening’. I have bought both new cars and used cars in my 25years of working and now that I am 50, I can say with a few years of wisdom under my grey hair that the joy of buying a new car is like falling in love. Yes it may last only for 3 months but those 3 months are worth it. Buy a new car I’d say even if you need to tighten up on other things for a few months BUT use it till it becomes 10% of your annual income as he says.

  3. Retireded says

    Buying awesome used cars is another art of being cheap. I drive a lexus LS, according to that chart I should make half to a million a year. But I bought a 12 year old one in great shape with reasonable miles for $5200 from a lexus dealership. That’s my second Lexus V8 and I’m in my mid 20’s. Blows the doors off buying a brand new piece of junk, and more reliable. You are taking a much greater risk with the German makes as they are much less reliable. Most people looking for a cheap reliable car buys civics, corollas hyundais etc, so there are no deals on them and in my opinion are excessively expensive used.
    Deals on larger luxury vehicles that burn a bit more fuel are a dime a dozen compared to small cars, and the gas difference between my car and a civic is negligible (IMO).
    Just like anything else, if you know the car market, you will always drive a great car as deals are ubiquitous.
    Other than ignorance, I’ve never understood why the average joe would want a new car, spend $18000 on a new kia rio or he could buy a 6 year old LS460 that cost like $80000+ just a few years before, and will outlast the newer car 9 times out of ten.

    • Drew says

      Because a 6 year old LS460 will have more expensive problems sooner “9 times out of 10″ than a brand new Kia Rio that will carry a warranty for at least the next few years.

      Buying used luxury cars is a great idea if you want the feeling of luxury without the price tag imo. But don’t try to make the argument that a 6-year old luxury car is more reliable than brand new car because that simply isn’t true.

      And also one thing that never changes is the cost of maintenance/repairs on luxury cars. It will always cost more to fix a car with an $80k MSRP than a car with an $18k MSRP.

      • says

        9/10 tims, Drew has no idea what he is talking about.

        Ask anyone familiar with Lexus, and they will tell you they, even though they are luxury vehicles with big V8 engines, are more reliable than alot, if not most cars out on the road.

        Mass produced, plastic junk like Kia Rio’s don’t hold up for nothing. You can scour the classifieds and find tons of high mileage Lexus LS’s and GS’s, but how many high mileage Kia Rio’s and the like will you find?

        That “warranty” also isn’t as reliable as it seems, as everyone who’s been to a dealership knows what to expect when they start going in there for the service work, and for serious problems that “should” be covered on the warranty. If you don’t mind playing phone tag with the service and dealership managers, mechanics, regional headquarters, all to just get what you thought the warranty would give you effortlessly, then go right ahead and play the games every dealership plays.

        They don’t make money on the sales of new cars. They make it by bleeding you every time you step into their service centers from then on out. The manufacturer already has your money they need once you pull it out the lot.

        Unless you are completely financially secure for years to come, there is NO reason to buy a brand new or within 2 year old car from the manufacturer’s dealership. It’s nothing but never ending hassles and games with them, and you automatically literally lose 10-25% of the value driving it off the lot.

  4. Jay says

    Preach!!! Thanks! I absolutely needed to read this.

    All in all, wonderful site. I’m turning 24 next month, have just over $10,000 in the bank. I’m getting antsy as to what to do about my money/lack of money. Your blog is really helping. :)

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