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

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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. Michael says

    So I struggle with this theory. I agree that taking on more consumer debt that you can handle is definitely a bad decision. I also understand that the 1/10th of gross income is a guidepost meant to get you thinking about how you allocate your hard earned dollars. That being said, I think there is a argument to be made for the utility for your dollars. What I mean by that if I receive more than a proportional level of utility from my car then i should tilt the % of gross towards those items that increase my total utility.

    For example if I make 100k a year the rule would suggest 10k for a car, financed over 60 month at historically low rates means I pay less than 200$ a month for the car payment. However I figure I get roughly 2X as much utility for this item vs other non essential monthly items….cable, internet, shopping, dining out etc. Therefore I can allocate a higher % of gross.

    That being said, I drive a 05 Nissan altima worth less than $4k and I make well into the six figures…

  2. Gordon Sutcliffe says

    It would be good to see the reasoning behind this 1/10th rule. I can’t see how it benefits anybody except to serve the American obsession of turning pots of money into bigger pots of money (the blogger shows a strong aversion to anything that depreciates not because of the effect on your actual financial health, which is what is really important, but simply because you missed the opportunity to turn that money into more money). That’s how this article reads.

    If you earn a good income and are not a slave to the stock exchange, I fail to see how spending a more sizeable chunk of cash on a car is going to hurt you financially. Indeed, if I earn $200,000 a year, apparently I should aspire to a Hyundai Genesis, despite this amount being in the “rich” income bracket.

    But if I earn post-tax $200,000 a year, and my living costs are, say, $50,000 a year, I could happily go out and buy an Aston Martin with the savings from that year and get back to saving/investing from there onwards. Even if you put aside $20,000 a year for running costs, you’re still saving $130,000 a year. So where’s the financial faux-pas here?

    There are people like the blogger who are not affected by the attraction of driving a nice car, which is great, but that does not mean everybody else should have to deprive themselves based on an arbitrary rule made up by people who want you to live to their standards.

  3. Gordon Sutcliffe says

    Thanks for the links.

    I think basically this rule ceases to be relevant after a certain upper threshold. The idea that somebody earning $500,000 a year after tax is being financially irresponsible by buying a Bentley is obviously idiotic.

    Whoever came up with the rule probably didn’t think it through that far. Sure, if you make $50,000 a year a car purchase will stretch you, because your budget is already tight, but at higher earning levels if you’ve still got $400,000 left over after all your living costs where is the logic in depriving yourself? Just so you can watch the numbers go up in your bank account a bit more than if you hadn’t bought a car? What’s the point in earning hundreds of thousands if you’re not going to use it?

    Money should never be an end in itself.

    • says

      Do you speak from experience? When I made $500,000, I had about $325,000 after tax. You are saying I should be comfortable buying a $150,000 Bentley? This is the type of spending that keeps people in the rat race for way too long.

      Instead, I saved and invested about $225,000 of the $325,000 every year, drove a sub $50,000 car and enjoyed the money elsewhere.

      Please tell me what your after tax income is after $500,000, your age, occupation and net worth so I can get an idea of where you are coming from.

      Thanks!

  4. Gordon Sutcliffe says

    I would invite you to read the second sentence more closely where it says “after tax”.

    In any case, one of the flaws with the 1/10th rule is that it disregards the fact that your earnings come every year, a sensible car owner will keep their car for years. So if you keep your car for, say, 5 years, using your figures you’ve earned $1.6 million after tax in that time, and spent $150,000 + running costs (let’s say $100,000) – resale value (say, $65,000) = $185,000. I think that means you’ve spent about 11.5% of your earnings over that period on an asset that is a big part of your life in social, pleasure and utility terms.

    Your living costs might come to about $300,000 in that period, so that leaves you with a saving of $1,115,000 in a 5-year period.

    For one of the most important assets in your household for work, social, pleasure, and freedom, I’d take that deal any day, thank you very much!

  5. Brice says

    I am an enthusiast. I know much about cars and how to mod them. It is an expensive hobby, but extremely satisfying.

    Worrying about parking in a crowded lot or tight spaces does not mean you can not afford the car, it means you respect your things and are happy with your riches and not piss poor, morally.

    Now, I am young (19 to be exact) and have probably driven more cars than most people on this page because of acquaintances (dealerships, shops, customization shops), targa trophy rallies and one gumball 3000 rally plus my dad is into cars as well.

    Ultimately, what I am saying without having to type a ten paragraph paper is to spend your money on what makes you happy. It doesn’t matter if you make 150,000 a year or 500,000 a year. If you want a nice, fast, 911S, go get it. :)

  6. Nick says

    I understand how this can be seen as good advice.
    However I will not live according to any of it.
    I alone make upwards of 200,000 annually.
    I do not want to sound arrogant but I feel it is needed for my example.
    I have been, and always will be, a petrol-head.
    Back in the 70s I built my Impala from stock to street king.
    Currently, I own a Dodge Viper SRT-10 (paid in cash), Dodge Challenger (Cash – Daily Driver), as well as an F-350 (paid in cash).
    My home is paid for, granted it was only 450,000.
    One thing you need to do if you want to be well off in the future is save 20% of every pay check and either invest it or put it into a savings account with interest.
    Start when you are 18 or so and just getting your foot in the door so you can plan ahead and force it into a habit.
    With everything paid off and have built a sizable portfolio, I am going to retire at 55 and have enough to live off of and still be able to pay for my grand child to go to college.

    • Nick says

      I forgot to add a few details.
      My wife makes, as much as I hate to say it as a man, more than me.
      She is a physician making 275,000 annually.
      Together we make around 460,000 annually from our employment alone. With investments into businesses, stocks, and flipping we can make more than 500,000 yet we are both getting to old to flip goods anymore.
      She drives a Maserati and a Range Rover. She likes imports, I still love her though.
      She agreed with me that living in an estate isn’t important as long as we both are comfortable and together. However she has been talking about moving and finding a place for retirement.

      • says

        I think if you are a multi-millionaire and have your debt under control with a wife who is a physician that can take care of the family, then you’ve definitely got the green light to go wild!

  7. Mark says

    Interesting read, but I must say I disagree with much of it. I see offhand two big problems with this article. The first assumes that users are buying a car and then spends the next few years paying it off. So, if thats the case, how long are they to spend making payments? Since we are talking about how much to pay up front, I think its much more important to say how much you will pay later since thats where the majority of the car will be paid for. How much per month for how many months? Actually, this is what lands millions of people in financial trouble – only looking at the cost right now and ignoring the cost down the road. Also, what if you have money saved up and can afford more than just 10% or a down payment? I would think it would make a difference if someone has 10K, 100K, or $1 million in the bank when it comes time to buy a car.
    The other problem is that it just isnt really realistic. This chart shows that in order to buy the cheapest of the new cars available today, you need to make at least $100K, and the chart goes on from there. There just arent enough people making that kind of money to supply the rest of the population with their used cars. Further, when I look at the average new cars listed between $150-250K, there are even fewer of these people. Beyond that, the average American, in the $25-50K range, cant even afford a car not potentially requiring major repairs in the near term. Cars from 2005 (at the newest end of the spectrum) are 9 years old; a quick search for $4000 cars on the internet revealed most such cars are actually 12-13 years old. These are cars with between 108,000 and 135,000 miles on them on average, though they could also be much higher. At that point, I’d be afraid of them breaking down and costing maybe 5% of your annual income just to get them running again. Seriously, if within 1 year you end up spending 15% of your gross income to buy a car and then get it fixed, wouldnt you be better off spending that 15% on the cost instead?

  8. Loohoo says

    Buying $4500 used cars…..you forgot that you’d be buying another jalopy $4500 used car every 4 years, versus paying $25K for one that will last 15 years. Add in the lost work time from babysitting all the extra repairs of a $4500 used car.

    No doubt, Americans need to save far more and spend far less, but enough with the hyperbole of $50K/yr nurses in $4500 beaters.

  9. GM says

    I have always bought new (since my first couple of cars), while my best friend has always bought old used cars such as you mention. Over the years, the amount of times he has broken down (on the freeway with the family) with different cars, didn’t have a car he could “Trust” to go on a long drive holiday with. In fact in his latest, he just paid $2800 to put a new transmission in (that would have been covered generally for the first 10 years on most power train warranties).

    Also, just because you haven’t had a problem with your latest car doesn’t mean that reflects the bulk of the older used cars out there. That’s like saying you haven’t gotten lung cancer smoking so everyone should smoke.

  10. Ben says

    Turns out I did this EXACTLY last year. I make $135k and bought a used car for $13,500. This same car was $35k new and only had 65k miles.

    It’s all paid off, unlike any of my previous cars that clocked in closer to 30-50% of gross (when that number was smaller).

    It could be more exact if we did a ratio based on disposable income after expenses. I just got married and have no housing expense (lucky me!) even though we will have to move soon. So I have the expenses I had in college and no debt payments. No student debt. I could definitely go past this threshold where someone with a mortgage and such maybe shouldn’t. But yeah, I’m hanging onto my 10% car and saving like a madman!

  11. Joe says

    Let’s say over a 10 year period, you drive 100,000 miles. The average speed of a car, factoring in highway driving, city driving, waiting at stop lights, maneuvering in and out of parking spaces, sitting in you car waiting for someone, eating, etc., is less than 25 mph. At 25 mph, it takes 4000 hours to travel 100,000 miles. With the average work week being 40 hours/week x (52 weeks – 2 weeks holidays – 3 weeks vacation + sick) = 1880 hours. So, you are sitting in your car for those 100,000 miles, an equivalent of 2 years and 2 months at work.

    If you can find a cheap car that is not a disaster to sit in, safe , truly economical, and that you over all enjoy being in and driving, go for it. If public transportation totally meets your needs, go for it. If not, I don’t see how punishing yourself for 10 years is saving you anything in the big picture, well beyond electronic digits. If I am 30 times more likely to be badly injured or killed in a 2000 Chevy Tahoe than a new Chevy Traverse, probably not a good decision to go with the Tahoe. If I get chronic back pain from driving a 2001 Honda Civic instead of a new Civic, probably not a good investment.

    • says

      Sure, I think a car 30X safer and one that doesn’t give you chronic back pain is worth buying over one that doesn’t.

      I also think flying private is more enjoyable than flying economy commercial.

      It’s whatever you prefer.

  12. Slking 91 says

    It must be nice to have made a comfortable living. That’s awesome. I hope one day I can live as comfortable as well. I could only imagine how less stressful of a life you have compared to me. Unfortunately my credit is whack, student loans and medical bills, and I’ve never touched a credit card in my life. I work part time at a small town grocery store and another job just 8 hrs a week. Making around or less than 800 a month. Not to mention I have a 1 year old. I do not receive assistance what so ever. I go to school as well. It’s not that I don’t want to do better, but I never realized how much I needed a vehicle to have more possibilities. I spent what I call an arm and a leg 4500 to get my license back after 2 years for a $100 speeding ticket, long story short… Mom offered to pay as a graduation present and forgot too. Pulled over and handed a driving under suspension. Thought to pay speeding ticket, but in all reality I had to pay for everything. Not much I could do when I was living 300 miles away from the nearest relative. Had to quit school, job, and move back home. Driving home I got pulled over again. Barred my license. It’s pretty embarrassing having a baby and have to ask for rides. So with this joyful rant coming to an end, times can be tough and unbearable. I think it’s amazing how some people can build a fortune or even be blessed to take over a family business. Something like that. I cant wait to overcome this mess I’m in. I play the lottery weekly, in last resort high hopes I win! Haha. Can’t win if you don’t play. Right?! Have a terrific day I enjoyed reading the back and fourth comments. Thanks for the laugh :)

  13. Steve says

    I have a question. I just recently graduated from college and started my job (28 years old), making roughly 60k before taxes. I need to buy a car and I’ve been doing a lot of research. I’ve read this article saying 10% and I’ve read another saying 20-35% and another saying 50%, lol. I have a 50k college debt which I will be starting to pay off soon, my gf owns a great house so I don’t have any living expenses, and I am looking to buy a new car. Originally I was planning on spending 30-40k as this will be my first car and want a nice, new car I’ve been wanting for a long time. I have 8k saved up which I was going to put down as a down payment regardless of how much I spend. Other notes: We have no children at the moment, gf has no debt and really high credit score, we’re planning on getting married within the next 2 years, and I do (more than likely) want to get my masters (or PhD) before I hit 32 (which will require me to stop working for 2 years :/). Is it really, really bad if I spend 30-40k on a car at this time?

    Thanks

    • says

      Please listen to my advice.

      If you have $8,000 saved up, you are $32,000-$22,000 short of affording a car.

      Go for a used $6 k car. Chances are HIGH with your debt level and savings and impending car payment you will regret not following my rule.

  14. Marcus says

    This is sound advice, wish I read this article a year ago when I bought my motorcycle. It cost me $7.5 k but I make $31 k a year. After the note and insurance, I’m out a little over $300 a month and that’s extra money I wish I could be saving to invest.

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