Opportunity cost is a spender's greatest enemy. Given America has a spending problem, our country will constantly be in grave danger without adopting better financial habits.
Back in 2018, I decided to join a Meetup softball league in San Francisco. I was one year into being a stay at home father and I needed to get out of the house more. Tennis had always been my sport, but I thought it would be nice to mix things up.
The softball league turned out to be a great outlet. I met people from various parts of the Bay Area from different socioeconomic backgrounds. The person I developed the best relationship with was with the organizer named Bob.
Bob is a preschool teacher who helps manage some of his parents' properties. As a property fanatic myself we talked about various investment opportunities.
Of course, I shared my enthusiasm for ocean view properties in San Francisco. Then I mentioned my heartland of America investment thesis. Who knew that today's global pandemic would accelerate the demographic migration towards lower-cost areas of the country.
The Arrival Of A New Tesla
Then one September 2018 weekend, Bob showed up for the game in a brand new red Tesla Model 3. The Model 3 had just come out and Bob crowed on and on about how amazing his car was. He even showed me how he could back his car up using his iPhone while standing outside.
I was impressed! But at the same time, I was dismayed that he had spent $53,000 for a car.
As the creator of the 1/10th rule for car buying, I strongly believe that paying much more than 10% of your gross salary on a car is a poor financial move. Paying too much for a car is probably the most common financial mistake Americans make today.
I didn't know exactly how much my friend made, but I was sure he wasn't making over $530,000 as a preschool teacher. As a 32-year-old preschool teacher, my guess is Bob makes about $70,000 a year. In other words, Bob spent a whopping 75% of his gross income on his new ride. The percentage is even higher if you calculate based on his after-tax income.
As a new friend, I wasn't about to judge Bob for his purchase. Instead, I just listened to why he loved the car so much. His enthusiasm was as high as a bench warmer who had just hit the game-winning single.
The True Cost Of Owning A Car
The true cost of owning a car isn't just the cash necessary to purchase the car. Other costs include:
1) Monthly payments
If you don't pay 100% cash for your car, you've got to pay a fixed monthly lease or loan payment. A lease payment is made to basically rent the car and return the car back to the dealer after a certain time period with zero equity. If you want to terminate the lease early, you will likely have to pay an early termination fee.
A loan payment, on the other hand, slowly pays down the debt owed on the car. Although you will eventually own the car outright, if you have an interest payment higher than 0%, your total cost to own the car will be much greater than had you paid cash up front.
2) Maintenance
Depending on your warranty, you will have to pay for oil changes, flat tires, and broken parts. Once, I had to spend $700 to fix my car fan because it inexplicably stopped working three months after my warranty expired. Murphy's Law of course!
3) Auto Insurance
If you plan to drive your car legally, then you must get car insurance. Even the most basic liability insurance will cost you several hundred dollars every six months. If you want comprehensive insurance, where your insurance covers all vehicles involved in an accident, expect to pay much more.
4) All Sorts Of Tickets
If you drive in a big city, expect to get everything from parking tickets to traffic tickets. Traffic and parking tickets are important revenue sources for the city.
It is not a mistake that some parking instruction signs are difficult and confusing to understand. If you don't get a parking ticket, you will likely get a street cleaning ticket. If you don't get a parking ticket or a street cleaning ticket, you may eventually get a moving violation ticket for not coming to a complete stop at a stop sign.
With budget shortfalls a very real concern due to shelter-in-place, expect the ticket police to be in full force once the economy reopens.
5) Accidents
Heaven forbid you ever get into an accident. However, the more you drive, the more likely you are to get into an accident. If you do get into an accident, expect to pay your full deductible. Once the insurance company covers the cost of repair, expect to get charged a higher semi-annual premium during the next coverage cycle.
I once accidentally scraped the side of my Honda Fit on a parking pillar while backing up. The total cost to straighten out and paint two panels was roughly $3,400! My $1,000 deductible was easily met and my car insurance premium went up for the subsequent 6-month insurance cycle.
Biggest Cost Of Owning A Car: Opportunity Cost
All of these costs are why following the 1/10th rule for car buying is important. If you keep your car purchase low enough, you can withstand practically any cost or surprise cost on the list above.
But there is one cost that may trump all other costs combined: opportunity cost!
After hearing Bob go on and on about how great his Tesla Model 3 was for three weekends in a row, I decided to test drive one to see what all the hype was about. Electric cars are awesome!
The test drive was an experience like no other. Driving a Tesla makes driving an internal combustion engine car feel so antiquated. Not only is the ride powerful and smooth, but every time there is a software update, the car performance gets a little better.
In honor of Bob's purchase, I announced on the FS Forum that I decided to buy about $30,000 worth of Tesla stock in October 2018 at $298/share. Then I decided to buy about $25,000 more stock for about $330/share because I had investing FOMO. I wanted to buy about the same dollar amount of stock as Bob had spent on his car.
Surely, the stock was going to be a winner!
Tesla ended up rising to $367 a share shortly after, making me a cool $11,500 on paper. During the next six months, Tesla began melting down as fears of bankruptcy emerged. By June 3, 2019, Tesla was down to just $179/share. My $11,500 paper profit had turned into a $20,000 paper loss!
Once again, I was reminded that trying to pick individual stocks to outperform the S&P 500 is a fool's errand. Luckily, the market has started to recognize the potential of Tesla's growth and re-rated the stock in 2020. One thing shareholders do know is that owning Tesla stock is going to be a very bumpy ride!
Related: What Should I Do With My Tesla Stock? Sell, Buy, Or Hold
Opportunity Cost Is Painfully Real
Although purchasing a Tesla car versus owning Tesla stock is perhaps an extreme example of missing a potential investment gain because you instead purchased an over-priced car, understanding opportunity cost is critical for controlling your spending.
Since 2009, the S&P 500 has been on a tear. Therefore, almost at any point since 2009, you could have invested in the S&P 500 and made more a year later.
Of course, there will be some bad years like in 2018 and in 2020 so far. However, over the long term stocks tend to go up at an 8%+ annual rate. Meanwhile, you can always invest in bonds, real estate, or other investment classes that have also historically gone up over time.
Below is a snapshot that shows the good and the bad of owning Tesla stock. After rising to $917/share on Feb 19, 2020, the stock quickly plummeted down to $361/share on March 18. I had given up almost all my gains. I was bummed.
When Tesla rebounded to $888/share on June 5, 2020, I told myself I've gotten really lucky. Given you can never lose if you lock in a gain, I decided to start selling some shares.
8 is a lucky number in Chinese, so I figured at a share price of $888 and an unrealized gain of ~$88,000, this had to be an sign!
Alas, we all know what happened next. Over the next 30 days, Tesla's share price rocketed 70%+ higher to $1,500/share! I essentially left about $80,000 on the table because I by then only had a measly 30 shares left.
Talk about terrible timing. Now watch me give up all my gains because I've decided to hold my remaining shares forever.
Always Calculate Opportunity Cost
Before spending money on anything significant, calculate all the direct costs associated with owning the item. Then calculate the potential opportunity cost because the opportunity cost could really be a killer.
Even if I didn't buy $55,000 of Tesla in 2018, I could have bought the S&P 500 which ripped higher by 30% in 2019.
If you haven't reached financial independence yet, then paying much more than 1/10th of your annual gross income on a car is not a great move. You could have invested the downpayment or the monthly payments in stocks, bonds, real estate, or other asset classes that have historically appreciated over time.
As for my friend Bob, he actually is experiencing the best of both worlds. Not only is he enjoying his Tesla Model 3 every day, but he also revealed he's a Tesla shareholder!
An Investor's Lament
Looking back, it's crazy to think that so many of us could have gotten extraordinarily wealthy by investing in Tesla and many other tech stocks in March 2020.
These investment opportunities are why I will consistently try and invest ~10% of my investable assets in individual stocks and other opportunities. These random opportunities are why we should always set aside a nice cash hoard as well.
Index investing is nice, but if that's all you do, you're never going to outperform the masses who own index funds. To gain real wealth, you must outperform. You can either outperform in your investments, your career, or your business. You might as well try and outperform in all three.
Of course, you might underperform with your individual investments. However, that's what getting rich is all about. Taking calculated risks beyond the average person. Good luck!
Update 2021: I so should have held onto all my Tesla stock! I would be up another $200,000 at least if I did. The stock looks like it's in a total bubble. However, bubbles tend to grow far beyond expectations. As of now, I have $130,000 of Tesla stock.
Related posts:
Don't Stop Fortune Hunting: Money Making Opportunities Are Everywhere
Suggested Mix Between Active Investing And Passive Investing For Greater Fortune
How To Predict A Stock Market Bottom Like Nostradamus
Be More Responsible Financially
Follow my House-To-Car Ratio guide for fiscal responsibility and buy a cheaper car. If you want to eventually reach financial freedom, you should have a house-to-car ratio of at least 50. Cars are guaranteed to depreciate in value, houses tend to appreciate in value.Â
As the father of the modern-day FIRE movement, I want all of you to have more wealth and more freedom. No car can match the joy you will experience once you are financially free.Â
Buy Real Estate Instead Of An Expensive Car
Keep your car expenses to a minimum given the high opportunity cost of owning an expensive car. This way, you can build more wealth and achieve financial freedom, which provides way more value than driving a nice car.
To invest in real estate without all the hassle and unexpected costs, check out Fundrise. Fundrise offers funds that mainly invest in residential and industrial properties in the Sunbelt, where valuations are lower and yields are higher. The firm manages over $3.5 billion in assets for over 500,000 investors looking to diversify and earn more passive income. The minimum investment amount is only $10.Â
Another great private real estate investing platform is Crowdstreet. Crowdstreet offers accredited investors individual deals run by sponsors that have been pre-vetted for strong track records. Many of their deals are in 18-hour cities where there is potentially greater upside due to higher growth rates. You can build your own select real estate portfolio with Fundrise.Â
I've personally invested $954,000 in private real estate since 2016 to diversify my holdings, take advantage of demographic shifts toward lower-cost areas of the country, and earn more passive income. We're in a multi-decade trend of relocating to the Sunbelt region thanks to technology.Â
Both platforms are sponsors of Financial Samurai and Financial Samurai is an investor in Fundrise funds.Â
I bought some Tesla stock back when it was about $100 a share years ago. I have a rule: if the stock doubles, I sell half my shares. That way, I get my original investment back. Everything left is pure profit. If the stock drops to zero, well, that sucks, but at least I don’t feel like I lost *my* money.
My wife and I also own Teslas. I saved for 5 years before buying my Model S P100D. After I got mine, we bought her a Model 3. With the (now expired) tax credit, we got more money back in taxes then we paid in interest on the Model 3 loan. (Paid off the loan in just over a year.) When I bought my Model S, I got double the tax credit she did and the loan interest rate was about 1/3 of hers. I’ll have the Model S loan paid off in a year and there is a good chance the same will happen with my loan.
Our cars are head and shoulders above every other car I have seen. Maintenance costs are virtually non-existent. No oil changes. No air or oil filter changes. No lube jobs. No spark plugs. Even tire rotations need to be done much less frequently than a traditional car (assuming you have a dual motor model). I was on vacation for a week and actually was looking forward to coming home just so I could drive my car again.
I blogged about my experiences with Tesla and the finances of saving for and buying it at my blog, Road To A Telsa.
Yeah I probably need to allocate some money to “long shots”. I used to do a lot of that in my 20s but sucked at it and never made much money. Maybe now that I’m in my 40s I should get back into it. A few months ago, when Tesla had taken a dip, I remember thinking about of buying a straddle on the stock cause I was sure that it would make a big move up or down in the following months. Never pulled the trigger but, damn that trade would’ve been my best ever.
And that’s one of my psychological issues with stock picking. I spend too much time obsessing over it; having FOMO, regretting selling early, regretting not sellinbg early enough. Combined with track record, I’m content to just stick with boring index funds. I admire you guys who pick winners every now and then and pull the trigger.
As for Tesla I couldn’t begin to explain the valuation. They’re still a car company at the end of the day. Sure, they have some novel ideas and some unique products but ultimately I dont think it’s enough of a competitive advantage to essentially take the majority of the market share away from other carmakers. And honestly, I dont even think its a done deal that battery powered EVs will turn out to be the successful formula over the long run for personal transport. As for autonomous driving, there are companies and people way smarter than Tesla/Elon Musk working on that as well. Tesla is good at tooting their own horn, but I dont think they have any actual technological lead in establishing a global fleet of level 5 taxis (which is the other way that I guess you could justify their valuation). Plus even if they could launch something tomorrow, it will be a long slog in terms of consumer and regulatory acceptance. [And no I dont currently hold any position in Tesla..just more of an eye roll at all the hype from them]
I bought 60 shares at around $200 a share back in 2016. At the time this was around 25% of total invested assets for me. I believe long term Tesla will become a multi-trillion dollar company, but the massive increase in valuation over the last month has been crazy. I know the disciplined thing to do is sell and take my winnings, but I’ve decided once I buy an individual stock going forward I’m not going to sell. I doubled down and bought another 16 shares between $1,000 and $1,400 a share. Going forward I need to allocate a percentage of savings towards individual stocks.
In 2002/2003ish I bought my first stock. My dad helped me open a Roth IRA and I bought 100 shares of Redhat for $6 a share. I sold a couple years later for a modest profit and took a draw from my Roth for a down payment on my first house. Redhat went on a massive tear and sold last year to IBM for $190 a share, DOH! Of course my original position was relatively small so it was no life changing amount of money, but still an amazing return.
Tesla vehicles are awesome technology wise, quality wise they rank behind luxury brands such as Kia, Chevrolet, and Fiat…but their owners don’t care because they love them! I get it because I’m a Jeep guy (car guy in general), and the quality is terrible in the grand scheme of things but there’s no way I’d trade a day of driving with the doors and top off for a Range Rover or some other modern day station wagon/soccer mom-mobile because I smile everytime I get behind the wheel. I get why people love all types of cars/trucks they are cool and tastes are very individual.
When it comes to Tesla stock though, I would not bet against it, but it is essentially trading at a value 20 years into the future of flawless execution and continued innovation. The winner is going to be whoever comes out with a true level 5 autonomous vehicle first, Tesla is currently not as good as the Cadillac Supercruise which is also on the road, but Cadlillac/GM do a crappy job marketing this. Ask any expert which is better, it is not close and true level 5 is still a decade away from mass acceptance both legally and technologically. That being said, with how fast technology advances, who knows Tesla could be there in a year or two and then their stock is probably valued accordingly, if not being a bargain.
What people fail to realize is that autonomous vehicles are going to decimate the auto industry as a whole. It won’t happen overnight, but 25 years from now they will not be building new homes that have garages anymore, there will self driving services of various luxury levels that you hit a button to summons. Vehicle volume will be half of what it is today. If some little guy comes along and nails the tech like Tesla nailed the electric vehicle, Tesla will either need to buy them (which is very likely), but there are a lot of really smart people working at big auto companies all over the world trying to be first, I’m looking forward to seeing how it all shakes out!
Can’t dog the Range Rover! I’ve had a 2015 Range Rover Sport since December 2016 and I love it. It’s totally reliable, fun to drive, and it feels good to transport my family in.
But alas, I should have invested even more into Tesla. Off to the next hidden gem.
Hey the RR Sport is a sweet rig! I’m just saying people’s tastes are different and you’d probably hate driving around in a rickety (by comparison) Jeep Rubicon but we love it and wouldn’t go back to the luxury SUV segment that I was stuck in for 20 years.
So I would counter and say that you shouldn’t have invested in Tesla vs. purchasing the Rover. You already have “enough” and I bet you cannot tell me one way your life would actually be different if you had instead continued to drive the “beater” and invested in Tesla. You’d still be a mildly frugal s.o.b. like myself who just has another million in the bank he won’t use! Once you’ve already won, use some of the “units” you’ve accumulated. You can’t take them with you.
Haha, maybe! I actually love spending my gains on real estate. Real estate continuously provides me the highest lifestyle return of all the assets. Gotta convert the funny money to real assets!
Have you seen the video of the Tesla crashing into an overturned semi? That’s scary. I’ll give them a few more years.
On the investing side, I’m terrible at picking individual stocks. I’m too conservative. When the stock goes up, I’d sell too early and miss out on the massive gain. That’s why I like dividend investing more. I could just hold, for the most part.
Anything negative is bullish for stocks and the economy. It’s what’s been happening since March 2020.
Terrible earnings in 3Q2020 may lead to all-time highs in the stock market.
We live in upside down world.
https://www.financialsamurai.com/maximum-unemployment-for-maximum-stock-market-returns/
I had bought 50 shares of Tesla when it was around $212. Went on a very bumpy ride when it went up to 370 and then below 200 a few weeks later.
I decided if it ever hit 370 again I would sell which I did. Got around $7k of profit. Of course it went bonkers after (and even had another opportunity to get back in at same price I sold in March but didn’t do it. And now it’s on a tear again. Would have been close to $70k in profit if I had held on or re-entered.
Even worse was the stock happened to be bought in my Roth IRA account and all gains would have been tax free.
While it does hurt to think of how much money you could have made if you kept all your shares, no one can time the market perfectly. Hindsight is 20/20
Bought at $60, sold soon after at $90. Made $12k. Even my great investments show I don’t what I am doing…
Back to constantly buying the index for me!
P.S. Just bought a new roof deck to materialize some paper gains following Sam’s advice and couldn’t be happier with the decision.
At least Bob got to drive that Tesla and sell it 3 years later for about $25000.
Great post Sam! Cars do seem to be one expense that a lot of people don’t truly factor in, even people that don’t really like cars can spend a fortune, often without even realising.
Another hidden cost that is kind of on par with the monthly payments is depreciation. This cost hits everyone so can’t be avoided, unless you’re into your classic cars!
People that buy new cars often don’t realise their car can lose 15-20%+ in value in the first year of ownership, madness!
Love your 1/10th rule, although unfortunately may have splurged a bit too much on my current car and broken more into the 1/5th bracket.
Managed to get a brilliant older car that looks excellent but has had most of the depreciation already, so yearly cost of ownership isn’t horrific, agree still probably too much though! Will keep your rule in mind when the next purchase comes in sight!
Well, you still win (gain) so it’s not a lost cause. Plus, you gained more than 100% return in over 1.5 years so it’s great. Long term capital tax too.
In investment, you can never predict what the highest price is. As long as it’s not a loss, you already win.
My Mom likes to say: if it’s yours, it’s yours =)
This reminds me of my Amazon stock purchase. I first got in at $438/share and as of market close on Friday it’s now at over $3200 a share with no slowing down in sight. I only own six shares but what a ride.
I think the whole fractional shares thing has really kept stocks like Amazon and Tesla skyrocketing. Do you think we’ve seen the end of stock splits as a result?
The Tesla thing makes no sense to me. Len Penzo discussed it in his black coffee series this week. We could easily afford a Tesla with your 1/10th rule, but I guess we are not that into status symbols and we have a perfectly good Prius and another plug in hybrid and we try not to drive too much. Wouldn’t Bob’s preschool staff be kind of taken aback by him driving a Tesla? I don’t think my patients would like it if they saw their pediatrician driving a Tesla. They would probably think they are being overcharged. Liking cars I’ve always thought it such a headache. I guess I see them as just functional things. But yes, opportunity cost is huge. And thinking about cars and Tesla stocks I think is an opportunity cost. I’d rather donate money and plant trees. So interesting that everyone is talking about Tesla stock these days.
Not the Model 3. Tesla is not a status symbol here in the Bay Area. They are very popular, like Honda Accords.
Maybe a souped up Model X would turn heads.
Since I keep missing to buy Tesla Stock. I decided to go with NIO for a ride and what
a ride it has been. Hope them Millenials(Robinhooders?) drive it up more.
What a great post because you and I am the same. I own 165 shares of Tesla – What a nightmare. I will never sell, which means I will own these shares when Tesla crashes – and it will crash. Because I never sell my winners, I am doomed.
This is not a negative post, except for the fact it tells the truth. So, let’s enjoy our good fortune knowing all good fortune has an experation date..
Teslas are cool cars. I randomly stumbled upon a Tesla show room in Paris several years ago and was really impressed. I see a good number of them in SF and always think they look nice when they drive by. I haven’t thought of buying one myself though. But I love your point about opportunity cost and buying the stock instead of the car! Their stock is off the charts, impressive! I don’t have the risk tolerance to buy single name stocks, but those who do and are shareholders like you have done quite well! Nice!
I started dabbling in individual stock investments over these past several months. I have learned that I am terrible at picking the winners and I have great investor lament because I sold Tesla stock at $695. If only would of waited a few more months. Oh well. Win some and lose more often haha.
I like index investing. Set it and forget it. I have never watched stocks more closely than when I started picking individual stocks. However, it is a little fun to watch the winners make a lot of money. Not so much fun buying one day then the stock tank the next.
Totally agree Sam wrt taking calculated risks and some of them may not pan out.
Same reason why I created a system for my moonshot portfolio and have been lucky to have Tesla in there.
Even if it goes to zero, the stock has provided me enough entertainment value. Plus it feels great to support an actual innovator.
I bought a Model 3 almost one year ago exactly and paid cash for the car. Had I bought stock instead, it would be worth around $450k today. I don’t regret the purchase though, no one could have predicted the meteoric rise in stock price.