I have to live in a bubble. Because in my circle, I don’t know anyone who owns a car that costs more than 1/10 of their annual income.
- My dad drives a 28 year old car that costs about $500 and has a state pension that is at least 100X that.
- I drive an 11 year old car that costs about $15,000 and my income is more than 10X that.
- A friend of mine drives a 10-year-old Tesla Model S that costs maybe $16,000 but makes over $5 million a year.
- A neighbor recently paid off his house and celebrated by buying a three-year-old Honda Civic. He is 42 years old and retired.
I came up with the 1/10 car buying rule 15 years ago to help people achieve financial freedom faster. Thousands have followed this general rule since then, but millions more have not.
If you had invested $60,000 back in 2012 in the S&P 500, you would have $405,000 today. But if you used that $60,000 to buy a 5 Series BMW, it would cost less than $9,000 today. Yet people still insist on buying cars at ridiculous prices when they are guaranteed to depreciate and rack up constant maintenance costs.
The car is the number one financial killer for most Americans. Therefore, your car payment is also the biggest roadblock you have to financial freedom.
Your Car Payment is Full of Investments
If you have a car payment, that money goes toward paying off a depreciating asset instead of investing in one that may appreciate. Car payments are also a distraction. Another financial account that you should stay on top of, instead of staying on top of your investments.
I found this insightful video on Twitter that highlights how a car payment can set you back financially. He is he may be joking about his large car paymentbut it is good to discuss because there are people in the same situation. Have a watch and listen:
This example hits home because my wife wants to be a full-time preschool or kindergarten teacher. So far, she has worked as a substitute teacher for $24 an hour for four days last month. If he works 40 hours a week, 50 weeks a year, he will earn $48,000 a year. This is more of an online school that is currently doing homework.
The woman in this video is a top-notch kindergarten teacher who makes $7,500 a month, or $90,000 a year. after taxes. I recommend him, especially if he doesn’t live in an expensive city like San Francisco, LA, Seattle, or New York. Also, I love how she spends $251/month on a gym membership and personal trainer. Exercise is important for good health.
However, with a $1,548 monthly car payment for a Mercedes Benz G Wagon, she doesn’t have much left over each month. In fact, he ends up with a negative $124, which he borrowed from a friend.
I used to have a G stroller myself
It’s funny, because when I was 25 I stupidly bought a 2002 G Wagon for $75,000. I had just received a promotion to join a base salary of $80,000 (up from $55,000) and a guaranteed bonus for coming to Credit Suisse in San Francisco from Goldman Sachs in NYC. As a naive young man, I decided to blow a ton of money on a car I didn’t need.
I thought it was a steal since the G500s were selling for $150,000 at an auction in Santa Fe, New Mexico last year. That dealership held exclusive import rights, which Mercedes bought. After only one year I got rid of my G Wagon when I decided to buy a condo. This thing was too tall to fit in the garage. In the end, I took a $17,000 shower on it.
It was actually that experience that led me to come up with the 1/10 rule for car buying. I remember seeing the car salesman throwing his arms up in excitement and calling out to his boss when I bought the car. I didn’t want anyone else to go through this financial folly that I had just gotten myself into.
Nothing Wrong with a $9,000 Car Instead
School teachers are the best. They have the most important job in the world and therefore earn less. But G Wagons cost between $150,000 and $200,000 today, which is 167% to 220% of his annual salary. That’s a far cry from my recommendation to spend 10% of your salary on a car.
Kindergartens won’t give you many gold stars because you showed up in a G Wagon. In fact, their parents may start asking uncomfortable questions when they see their child’s teacher pulling into the parking lot in a $150,000 SUV.
A $9,000 used car will do just fine for this teacher making $90,000. There are many models to choose from.
IX Factor: The Active Partner
What comforts me about this situation is that this kindergarten teacher has a partner who paid her electricity bill. And since I believe that people are generally wise and rational over time, it makes sense that his partner might make enough money that he felt secure buying a $150,000 car with a $1,548 monthly car payment.
Based on my 1/10 rule, their household income should be between $1.5 and $2 million per year. So her husband may be taking home more than $1.41 million a year, putting him in the top 0.1% of earners. It’s great when he does.
Even if they ignore my 1/10 rule completely and spend about 20% of their household income on the purchase price of the car (1/5th), they probably make $750,000 to $1 million combined. Not bad as a top 1% earner.
I refuse to believe that with all the free financial education out there, this family will knowingly spend money and condemn themselves to work forever to fund luxury expenses. Then again, making a social media video about it is a no-brainer, which is why I’m sure you’re hilarious to watch.
After all, investing $150,000 today with an 8% annual return leads to $323,850 after 10 years. That’s a nice chunk of change!
Make Smart Decisions and You’ll Be Financially OK
At the beginning of this article I was surprised by his car payment. But if you think about it logically, this teacher and her spouse will probably be fine. He has friends who will float him when he is short. She has a husband who covers fuel and extras.
Eventually you will be okay. Because if this car payment was real and things got tough, or he decided he wanted to get out of school right away, he would logically sell the car and reduce his expenses. Until then, she’ll love going to school in a $150,000+ car and basking in all the attention she gets. Right now, those benefits outweigh his costs. And that makes perfect sense. You do it yourself.
There is one thing I want to point out, and that is that the ratio of his house to the car is completely incorrect.
One of the silent pitfalls of renting is having a large monthly income, which makes it tempting to splurge on things like a luxury car. That’s exactly what I did the first three years out of college. I bought a Volvo 850 GLT, a BMW 5.40, a BMW M3, and a G-Wagon as a car enthusiast. It’s easy to do if you don’t have a mortgage looking down on you.
If she and her husband want to truly improve their odds of becoming financially independent, they should become residence neutral by owning their primary residence. After that, get the house to car ratio to 50 or less. With a $9,000 car and a 30 rating, all he needs is a $450,000 house to overcome that struggle. Otherwise it’s a forever-to-death job, which sounds amazing but is just math.
Student Questions and Suggestions
Readers, why do some people take huge car payments for an asset they know will only go down in value? Do you think car payments are the most common barrier to financial independence? Why not just buy a cheap sidecar and invest the difference? No one has stopped you in any way. Just be aware of the tradeoffs.
Instead of buying an expensive car with a huge car payment, invest that money in the S&P 500, bonds, and real estate. Ten years from now you’ll be glad you did. Personally I’m dollar cost average Fundrise commercial real estate right now because the valuation is low compared to stocks. With four years of construction under construction due to high interest rates, I expect upward pressure on rents and prices in the coming years.
Fundrise is a long-time sponsor of Financial Samurai and Financial Samurai is a six-figure investor in Fundrise products. I am looking to diversify and earn more real estate income compared to managing rental properties which is a PITA.
