When buying a car, it is important to consider how much you should be spending. In today’s society, cars are not there just there to get us from A to B, they are more than that.
For some, they are a source of entertainment to see how quickly you can get from A to B. For others they are a way to travel remote parts of the country in search for the best fishing hole and, for a lot of people, they are a status symbol.
It’s unfortunate, but if the only thing you know about someone is the car they are driving, then you are likely going to make assumptions about their level of wealth and how success based on that one visible aspect.
Now as a Financial Adviser and as someone who has dealt with many, many people over the years (both rich and poor) let me say that these preconceived ideas that we arrive at are often completely false.
If anything, I have found that poor people spend way too much money trying to look rich (and a car is a good way at doing this) and rich people tend not to care about impressing others so unless they have some sort of passion for cars. They typically focus more on a practical solution.
The sad part is the poor people who try and emulate the rich by spending too much on a car end up staying poor as a result. They want the rich lifestyle, but their short-term choices are causing them to remain poor. With the availability of credit for car purchases, it is very easy to spend more than you should on a car.
So lately I have been asking myself – how much should you spend on a car? After a good amount of deliberation, I have an answer for you.
The smartest and most accurate answer is as little as possible. Cars are not an asset, they are a liability. They are expensive to buy, expensive to run, expensive to insure and typically they depreciate in value every year. The more you spend, the higher these expenses go.
However, I must admit that I am a car guy. I get enjoyment out of having a well-engineered piece of motoring perfection. I like the sound, I like the speed, I like the tech and I like the look. So then for someone like me, that doesn’t simply want an A to B car, what is a reasonable amount to spend?
If you ask most people this question, I’m sure a lot of people would base their purchase price on how much they earn or worse yet, how much they can borrow. I personally think this is a very flawed method.
Firstly, I don’t believe in borrowing money for cars, or any other form of consumption, so I would never suggest you base your car purchase price on how much you can borrow. Only do this if you enjoy being broke.
I also don’t base the price of a car on how much income I make because income is not a measure of wealth, your net asset position is. You can make a million dollars a year but if you spend it all and have no financial assets to show for your hard work, then you are worse off than the person earning $50,000 a year and putting aside 10% of their wage.
The methodology that I use to determine an appropriate purchase price for your car is a percentage of your net asset position. This is your true measure of wealth and therefore should form the basis of how much you can spend on life’s luxuries (like a nice a car).
If you are not aware, your net asset position is your assets (what you own) minus your liabilities (what you owe). When doing this calculation, I only include financial assets like real estate, cash, shares, superannuation, etc. I don’t include consumption items like cars, jewelry, white goods, etc.
Under my methodology, your car should be worth no more than 10% of your net asset position. A lot of the sensible people out there would be saying “10%, that’s a lot!” and you’re right – 10% is the absolute max. Of course, the lower the better (from a financial standpoint) but if you are a car enthusiast like me, then splurging out with a 10% spend can be justified.
This means, if you have a $500,000 net asset position, you can purchase a car with a value up to $50,000. If you are a couple, and $500,000 is your combined net asset position, then the combined value of both your cars shouldn’t exceed $50,000.
By following this formula, the amount you spend on luxury items like a car is always going to be relative to your wealth – as it should be! The person that has a $1 million net asset position can’t go and buy a $500,000 Ferrari because that’s 50% of their net worth. But the person who has a $10 million dollar net worth, can justify buying two $500,000 Ferrari’s if they want.
That doesn’t mean buying two Ferrari’s is the smart thing to do, but you have worked hard and earned the right to have those Ferrari’s if that will bring some enjoyment to your life.
Now there are times where I would definitely recommend spending less than 10% of your net asset position on a car. For instance, if you are a pensioner and have $1 million in your nest egg but no future income earning capacity, then the opportunity cost of spending $100,000 on a car would be too high. You would be better off using that $100,000 to generate future cash flow.
In my personal situation, I am currently rocking a 2019 Toyota Camry – the classic old man’s car. It cost me $25,000 which is nowhere near 10% of my net asset position. However, I have plans of where I want to allocate my capital to build my business and my net worth, so I don’t want to allocate it to a car at this stage. This doesn’t mean I won’t buy something nice in the future.
The takeaway message from this is, it’s okay to have nice things in life if you can justify them. However, if your net asset position doesn’t justify the luxury items, then don’t buy them, and especially don’t borrow to buy them. Doing so is not a good use of your cash flow or your capital and will keep you broke in the long run.
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