Everyone has tried to figure out how much they should spend on a car at one point or another. We bought our last car around 5 years ago. We’re hoping to keep it another 8 to 10 more years, so hopefully, I won’t have to ask about it again for awhile.
We bought a Subaru Forester because it was cheap and perfect for a growing family, New England snow, a muddy dog, and the beach sand. We bought an Acura MDX, because the family grew bigger, my wife’s commute is longer, and the luxury makes a difficult day bit better.
However, yesterday, I came across a Tweet that made me think:
Just saw another bad car-buying rule of thumb:
"Never spend more than 5% of your net worth on a car."
???
Some people have a negative net worth and need to get places to change that.
— Stephonee | PoorerThanYou (@stephonee) April 13, 2019
Now obviously it makes sense that people with negative net worth still need to have a car. However, I had never thought about tying the amount of car to net worth. It didn’t seem to make sense at first.
Then I thought about it in terms of my own money journey. It seemed to fit, but maybe it was a little low. Here are some examples:
| Net Worth | Car Price (5%) |
|---|---|
| $300,000 | $15,000 |
| $500,000 | $25,000 |
| $800,000 | $40,000 |
| $1,200,000 | $60,000 |
| $1,500,000 | $75,000 |
What I like about this is that it seems to curb lifestyle inflation. I think that was intention of the advice, but I don’t know where it originated. Besides the error, for low/negative net worths, it was too strongly worded for me. I rarely like to give advice by telling people what to do. Instead, I like to just explain what I’m doing and why I’m doing it. Your situation may be different, but maybe by following along with my thinking, you’ll be able to adapt it to your own.
So let’s pretend that I feel like buying a $75,000 luxury car. I look at the chart and see that it matches up with a $1.5M net worth. I’m not a fan of buying expensive cars, but if you have a 1.5M net worth, a $75,000 car is probably going to work out.
I decided I’d try to make the advice a little better by eliminating the negative/low net worth problem and making it more flexible (removing the “never” language). So I went with:
What if we try to fix it? Something like "Buy the cheapest reliable car that fits your needs. If you want a better car try to spend less than 5% of your net worth."
Feel like there should be some income guidelines too.
— LazyManAndMoney (@LazyManAndMoney) April 14, 2019
It was kind of a quick thought and while it is better, it’s not all that great. I think it keeps the flavor of the original advice which is all I was trying to do.
However, what if I tried to do more? What if I tried to come up with a very good answer for…
How Much Should I Spend on a Car? (Formula 1)
I think any formula is going to be doomed to failure. Nothing is going to work for everyone. People value things differently. For some, like my wife, a car could be one of the few luxury they car to spend money on. For others, like myself, a car is a convenient way to get from point A to point B.
It’s very hard to find “universally accepted” advice in personal finance. At the same time, if we can help a bunch of people with a rule of thumb, why not give it a shot?
With that in mind, I came up with three concepts that I wanted to be part of a rule of thumb:
Net Worth
As I mentioned above, I like the idea of incorporating net worth. It can be used to give license to people who have done a great job saving. It can also be used as a check to stop you from buying too much car.
Negative/Low Net Worth
We have to incorporate something that allows everyone to buy transportation. It might not be great transportation, but we can’t say, “Sorry, you can’t have a car to make money.”
Income
If you are making a lot of money, but just starting out a career with low net worth, you should be able to get a more expensive car. If you are low income, a lower priced car is going to be a better fit.
I fired up my spreadsheet program and created my first formula. It was:
Since I’m still trying to figure out how to write a calculator for WordPress here’s a table of what that formula might look like:
| Income | Net Worth | Formula |
|---|---|---|
| $25,000 | $0 | $7,500 |
| $50,000 | $0 | $10,000 |
| $75,000 | $0 | $12,500 |
| $100,000 | $0 | $15,000 |
| $125,000 | $0 | $17,500 |
| $25,000 | $25,000 | $8,500 |
| $50,000 | $25,000 | $11,000 |
| $75,000 | $25,000 | $13,500 |
| $100,000 | $25,000 | $16,000 |
| $125,000 | $25,000 | $18,500 |
| $25,000 | $50,000 | $9,500 |
| $50,000 | $50,000 | $12,000 |
| $75,000 | $50,000 | $14,500 |
| $100,000 | $50,000 | $17,000 |
| $125,000 | $50,000 | $19,500 |
| $25,000 | $100,000 | $11,500 |
| $50,000 | $100,000 | $14,000 |
| $75,000 | $100,000 | $16,500 |
| $100,000 | $100,000 | $19,000 |
| $125,000 | $100,000 | $21,500 |
| $25,000 | $250,000 | $17,500 |
| $50,000 | $250,000 | $20,000 |
| $75,000 | $250,000 | $22,500 |
| $100,000 | $250,000 | $25,000 |
| $125,000 | $250,000 | $27,500 |
| $25,000 | $500,000 | $27,500 |
| $50,000 | $500,000 | $30,000 |
| $75,000 | $500,000 | $32,500 |
| $100,000 | $500,000 | $35,000 |
| $125,000 | $500,000 | $37,500 |
| $25,000 | $750,000 | $37,500 |
| $50,000 | $750,000 | $40,000 |
| $75,000 | $750,000 | $42,500 |
| $100,000 | $750,000 | $45,000 |
| $125,000 | $750,000 | $47,500 |
| $25,000 | $1,000,000 | $47,500 |
| $50,000 | $1,000,000 | $50,000 |
| $75,000 | $1,000,000 | $52,500 |
| $100,000 | $1,000,000 | $55,000 |
| $125,000 | $1,000,000 | $57,500 |
That’s a long table, but hopefully you can find some numbers close to your own to get a quick estimate. If you need more rows at the end, that’s a good “problem” to have.
As you can see, everyone can buy a car of some kind. If you make more money, you can buy more car. If you’ve had a history of saving and growing your net worth, you can buy even more car. We can play around with the numbers some, but I’m thinking that income should possible be a bigger factor. Since these numbers are estimates, I’ll let you experiment on your own. Please let me know in the comments if this produces a good estimate for your own financial situation.
How Much Should I Spend on a Car? (Formula 2)
Something doesn’t sit well with me on that first formula. It doesn’t factor in other expenses.
If you make $125,000 a year, but spend almost all of it on housing, child care, student loans, etc. you aren’t going to have much left over for a car. On the other hand, if don’t have any of those expenses (limited property tax on a house already paid off), you are going to be able to afford more car.
So rather than just use income by itself, I decided to come up with numbers of income – necessary expenses. My working formula is:
Here’s another rough table using several income minus necessary expenses numbers:
| Income - Expenses | Net Worth | Formula |
|---|---|---|
| $0 | $0 | $0 |
| $4,000 | $0 | $800 |
| $8,000 | $0 | $1,600 |
| $12,000 | $0 | $2,400 |
| $16,000 | $0 | $3,200 |
| $0 | $25,000 | $1,250 |
| $4,000 | $25,000 | $2,050 |
| $8,000 | $25,000 | $2,850 |
| $12,000 | $25,000 | $3,650 |
| $16,000 | $25,000 | $4,450 |
| $0 | $50,000 | $2,500 |
| $4,000 | $50,000 | $3,300 |
| $8,000 | $50,000 | $4,100 |
| $12,000 | $50,000 | $4,900 |
| $16,000 | $50,000 | $5,700 |
| $0 | $100,000 | $5,000 |
| $4,000 | $100,000 | $5,800 |
| $8,000 | $100,000 | $6,600 |
| $12,000 | $100,000 | $7,400 |
| $16,000 | $100,000 | $8,200 |
| $0 | $250,000 | $12,500 |
| $4,000 | $250,000 | $13,300 |
| $8,000 | $250,000 | $14,100 |
| $12,000 | $250,000 | $14,900 |
| $16,000 | $250,000 | $15,700 |
| $0 | $500,000 | $25,000 |
| $4,000 | $500,000 | $25,800 |
| $8,000 | $500,000 | $26,600 |
| $12,000 | $500,000 | $27,400 |
| $16,000 | $500,000 | $28,200 |
| $0 | $750,000 | $37,500 |
| $4,000 | $750,000 | $38,300 |
| $8,000 | $750,000 | $39,100 |
| $12,000 | $750,000 | $39,900 |
| $16,000 | $750,000 | $40,700 |
| $0 | $1,000,000 | $50,000 |
| $4,000 | $1,000,000 | $50,800 |
| $8,000 | $1,000,000 | $51,600 |
| $12,000 | $1,000,000 | $52,400 |
| $16,000 | $1,000,000 | $53,200 |
Is this calculation any better? It’s certainly a little more complex. I’m not so sure because it’s harder for me to test. I don’t have a good set of numbers to plug in. This is where I could really use your help. If you could let me know in the comments I’d appreciate it.
Final Thoughts on Car Spending
Just before publishing this, I decided to do a little reading to see what the experts say. Many suggested using a debt percentage and limiting your debt overall. I didn’t like getting into that because sometimes there’s good debt and bad debt. It’s reasonable to consider it though. You’ll also have to think about all the extra costs associated with a car, from insurance to storage with Auto Vault, they all add up.
At the end of the day, the estimate is just that… an estimate. There are things you can do to get more value for your dollar when spending on cars. Here are some tips to save money on cars and how to save money on gas.
Here’s the WordPress plugin that I use for calculators. https://wordpress.org/plugins/calculated-fields-form/#installation
Editor’s Note: He sent me an example of it working: Example http://www.littlemn.com/2019/04/lazy-man-calculator/
As an engineer I like the thought you put into this. Just for fun I calculated the percent of net worth I spent on my daily driver I bought with cash last year. 0.2 % , and I love the car!
Thanks Patrick. I knew there were some solutions out there. Since I was writing it after midnight, I had to take a short cut. I’ll update the post when I get a chance.
That’s really something to have it 0.2%. I hope that means you have a big net worth! If not, I commend you on enjoying your used Yugo ;-).
The Subaru that I mentioned was just a little under 5%, but because that was 7 years ago our net worth has gone up and it would be a tiny fraction now.
I have a decent net worth, but I’m not Scrooge McDuck. Mostly I got a great, high mileage, older sports car for almost nothing. If it lasts a couple of years I’ll be happy.
I like the table, but I don’t think it works once you get to the edge.
We have a high net worth, good income, and don’t spend much.
I’m not going to go out and spend $50,000 on a car. We drive less than 6,000 miles per year.
A car is not that important to us. I haven’t shopped for a car for almost 10 years so I’m not sure how much they are now. In 2010, my goal was to spend less than $20,000.
Today? I don’t know. My cap probably isn’t much higher than that. Maybe $25,000.
I hope this car last until our son goes off to college, but we’ll see.
I view this more as what you might be able to afford to spend and still be very prudent with your finances.
It doesn’t mean that you have to spend $50,000, but that you can probably safely do so.
Wait a minute, you mean I shouldn’t be spending over $100k on that Tesla Model S? Blah!
One of the things to consider is how long you plan to keep the car. If you’re spending $40k on a car but change it for something newer after 2 years, that probably makes no sense. However, if you’re spending $40k on a car and drive it to the ground, that makes a lot of sense.
That’s a good point Tawcan. If you are getting something every 2 years, it probably makes sense to lease.
I would go so far as to say that this 5% rule of thumb is basically useless without taking into account how long you plan to keep the car. In an extreme but not impossible example, if you got a new car every year, you would be above the 4% safe withdrawal rate.
I’m presuming that you are selling the old car. That would still be a poor financial move to make every year, but at least it wouldn’t be financial death of 20 cars sitting in a garage.
Actually I think the 5% rule came from Financial Samurai, who also came up with a 10% of income rule of thumb with the same problem.
I think one of the problems with these calculations is that people with lower incomes are the ones least equipped to handle pricey car repairs that come with cheaper (read: older) cars. That said, they’re also not going to do great with a high car payment on a new vehicle. So I’m not sure what the answer is there.
I’m not going to tie my car purchase to my net worth. I’m just saving up money each month to be ready once the time comes for a new car (may that be many, many years in the future!) so that I’ll have a sizeable down payment or, hopefully, enough to buy outright. I may commit the true cardinal sin of buying new too, since if I go with a Honda or Subaru (the two I’m inclined toward), the price difference on gently used cars really isn’t that noticeable. But I’ll fall off that bridge when I get to it.
Usually the answer is to get a car that isn’t older, but one that has few features, like a 5-6 year old low model Kia or Hyundai. Hopefully that provides reliable transportation and minimal car repair costs. It’s been awhile since I’ve been shopping for cars, and hopefully the $5000 floor can get something there like it used to.
When we got our Subaru Forester going for gently used didn’t save us much at all. In fact, I think we did better with new, because we’ll get a year or two extra in the end.
For the most part, I’d use net worth as a sanity check. Planning to buy a $75,000 luxury car? Do you have a net worth of 1.5M? If the answer is no, maybe think about it some more.
MMMMmmmm Maths questions .. Drooolllll :)
While I like the approach, I wonder about a few things. How long do you intend to keep the car? How much maintenance do you expect to pay on the car? How much for insurance? How much to license and property taxes (where applicable)? How much for gas for expected usage?
While I hate the whole monthly payment method, I kind of look at it as you should spend no more than 10-15% of your NET income on your transportation costs (outlined above). That goes right along with no more than 30-35% on your living situation. So basically if you are spending more than 50% on your housing and transportation you could be trouble.
Yes you can get an older car, that is reliable-ish that should run well for several years for $5k (assuming you change the oil, etc.) I have known people who buy cars every few years, while used, still cost a lot of money where they have not paid off the old one and buy the new one because they were bored or what not with the existing one.
The overall goal is to get to the point where you have no payment, the car is paid off, and you have something that is hassle free for several years to come.
Glad you like the math post Big-D. I was excited to write about this one.
I wanted to use a minimal amount of data to get to something that was (hopefully) useful. I didn’t want to get into total transportation costs. Then you start getting into an area of recommending one type of car over another. That’s a good conversation to have, but it would probably be a series of posts or a book to do it well. I do like the idea of keeping it all in the 10-15% range.