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 $50,000 today given the stock markets are now at record highs!

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 that now costs $32,000 in 2015 is financially absurd. Who spends ~72% of their gross salary on the purchase price of a car? Worse yet, after you pay a 20% effective tax rate on your median $42,000 gross income, you’re now spending around 95% of your net income on a car! That’s crazy and a sure path to financial mediocrity. Don’t expect the government or your rich Uncle to bail you out.

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 Car Buying Chart Recommendation For 2015

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 FOR GREAT WEALTH 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

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.

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.

Updated on 2/26/2015 to include all the latest and greatest cars out there. I recently got a 2015 Honda Fit and love it as a city resident with limited parking. In three years, I’m looking to take down the latest Range Rover Sport if gas prices stay depressed.

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. Sam focuses on helping readers build more income in real estate, investing, entrepreneurship, and alternative investments in order to achieve financial independence sooner, rather than later.

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Comments

  1. Tony says

    If your overly conservative this a great approach. Maybe for people who lack ambition in life?

    Why would I want to drive around in a busted 15 yr old Lexus or drive a generic box on wheels? In life you are supposed to enjoy the things you work hard for. If your only making $40-50k per year your not going to get rich or be rich.

    To say your going to risk $10-20k on stocks is also a risk and some would say a bigger risk than buying a reasonable car. I think when people fail it’s when they make $40-50k and they want to buy something beyond their means. Nobody that make $200-300k is going to drive a $20-30k vehicle very rare and I think if they are making enough they are smart enough to continue to earn at the level or earn more (because they are already doing it).

    The best way is to buy a car 2-4 yrs old with low miles you get a deep discount and the car is still new. It’s also not smart to put 20% down into something that depreciates. Put little to no money down and BUDGET your money accordingly before you make a purchase.

    Be realistic but don’t be a penny pincher all the time you will get no where in life. Some would if your a hard work, smart and ambitious having a few “more expensive” items will make you work harder and hustle…..

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