My first car cost me $600 and I paid in cash. My second car cost $18,000 and I financed it at 6% for 5 years. My current car again cost $18,000 and I paid in cash. After that second car and upping my financial know-how I approached my third purchase with logic instead of emotion. I’ve learned even more since that last purchase, and continue to polish up my car buying approach, which I will be sharing in this post.
My History with Cars (abridged)
1st Car – BMW e30 – $600, CASH
This car will always possess a bit of magic. Despite its salvage title, its unknown mileage (the odometer was stopped at 185,000 when purchased), and its three different color body panels, 16-year-old me simply did not care. For six years, this unassuming car could do everything my lifestyle demanded. Easily the best $600 I ever spent.
I always did my own maintenance. I became deeply involved in the e30 community. I even started a website, albeit on some freebie host. But that car lasted for 6 amazing years. It piled on the miles during the summer. It safely navigated the worst of winters. It even took a few attempts at “off-roading.” At some point I even mounted THREE kayaks to the roof (in fact each kayak was worth about $1400, SEVEN times the value of the car!) It did double triple? duty as a moving vehicle on my way to and from college.
Eventually, she met her end one morning and I was unwilling to attempt the repair. A recent graduate at the time and making a decent salary, I decided to donate my old friend and upgrade to something “nicer.”
2nd Car – VW GTI – $18,000, 5yrs @6%
Back then without much regard for my financial well-being, I ended up spending about 39% of my gross salary for the new-to-me ride, a used VW GTI. Then taxes, then insurance, and it was all financed at 6% or so. Dumb, dumb, dumb. (Want to make it worse? I was paying close to $1000 a MONTH in student loan debt. At least I was smart enough to pay off my credit card every month. :rolleyes:)
The biggest difference between the e30 and GTI: the GTI has airbags. Otherwise, both got me from point A to point B in the same time. I could still load any number of things in it or on it. Just imagine framing it this way: I could buy my original $600 car, every two months with my GTI car payment that would last five years. That’s 30 cars! If each lasted 6 years, that’s two lifetimes! Oops!
3rd Car – Toyota Prius Plug-In – $18,000, CASH
I’ve loved this car for the past year. The image is from one-year in and shows the incredible gas mileage (and electric range!) I am getting. That is just over 55 MPG in hybrid mode! So far I can’t find any reason to complain about this car. Maintenance is low – as expected – and daily driving is great. It’s not the most spirited drive, but I finally realized I use my car to commute and that’s about it. The Prius fits my lifestyle perfectly.
Beginning to Learn
Here is my point. A car does not need to be expensive to fit your lifestyle. In fact, an expensive car is never a good purchase. In the e30 I’d never care about where I parked it, or if it got dinged or scratched. However, the GTI required extra babying solely because of the expense compared to my income at the time. So the GTI ended up being a new-to-me car that was outside of my budget which translated into added stress. The Prius is a bit in between the two. I make an effort to keep it safe, but I am never too worried about scratches or dings. It fits my lifestyle and financial goals.
Attacking your Car Purchase with Logic and Math
A car purchase is not something you should approach with emotion. All those feelings you have about getting that sleek, black two-door coupe – yeah, that’s just marketing and peer pressure. For most people, a car has one job: move you safely from point A to point B. All the extras (windows, doors, round wheels… ) are just marketing gimmicks. Okay, fine you need those three. But, power seats, iPhone compatible, and AWD – THOSE are marketing.
As such let’s make sure you take a thoughtful, logical approach before handing over that fat check or stack of cash.
Steps to Ensure your Purchase Matches your Situation
- Review your lifestyle. Seriously, think about how you use your car now. 95% of folks will use it to get from point A to point B, sometimes point C. That same 95% primarily drive on smooth paved roads at moderate speeds.
Now think of the last time your car prevented you from doing an activity you enjoyed. Maybe you went skiing last winter. I bet you either carpooled with someone else – or drove your car and made it just fine.
So first step: write down the realistic purpose the new car needs to fulfill.
- Beware the marketing monster. Do you need power seats? How often after setting up your seat position do you need to change it? Rarely. Don’t let the plethora of choices and shiny objects distract you. If you’ve been getting by without them, you can likely continue without them.
Write down what features you consider needs, then separately write down everything else under wants.
(One caveat here: safety options. I place no negatives on pursuing a certain model or feature if it genuinely offers improved safety. Driving is dangerous – a few hundred extra to be safer is EASILY worth it.)
- Be realistic with your budget. See how much budget space is available to use on a car purchase. If the space is not as much as you would like – too bad. Alternatively, take a closer look and see where you could pare down, perhaps those late night ice cream runs. We will get back to this, but for now write down how much room you have in your budget, to give you a ballpark estimate. The end goal here is not to spend 100% of budget space you have left!
- Do not forget that your budget needs to include the extras: taxes, registration, insurance, maintenance, repairs, gas, parking, whatever other car-related purchases you will experience. These add up quickly!
- Don’t just consider monthly budget, but also consider your yearly gross income as an indicator. Somewhere between 10-25% is common – I think 15-18% of your yearly gross income is the sweet spot for a purchase price.
Before we begin a purchasing analysis, let’s bring in my final preparation point:
- Do you actually need a car? Instead consider public transportation, a bicycle, walking, or carpooling. You know at this point your lifestyle, and the purpose and requirements a new car will fulfill. But, consider for a moment a zero-car life. Could you make it work? Really think about it. Also remember, not owning a car will not prevent you from using a car when needed. You can rent, you can ride share, you can borrow.
Matching your Financial Goals to your Car Purchase
I’m going to introduce a simple concept, then lay out a method for utilizing the concept to evaluate EVERY car purchase scenario. We are going to run through 5 example situations using this model. At the end you can download the worksheet I created to model all of this and model your own scenario.
Anyone with financial independence goals is likely already familiar with the time value of money. Why? If you invest your money into real estate market or the stock market, you are intending for your investment to grow. That growth you experience is time infusing its value right into your investment.
Of course, this can also work in reverse. A dollar spent today immediately makes that dollar unavailable to grow over time – because it is no longer in your possession! So when considering a big purchase like a car, or house, you really need to understand whether it is the best use of your income. Is the expense of the purchase worth missing out on the growth your money could be experiencing? Framing your purchase this way, we can see how well a new-to-you car fits with your financial goals.
Spreadsheets make this easy by using a formula to derive Net Present Value. Simply, this is a calculation that measures future value based on cash flows over a period, including adjustment for the time value of money. Others have explained it so much better here: https://www.mathsisfun.com/money/net-present-value.html
In our examples below, the more positive, the value (they are all negative, so for us, it’s just the higher line) is the optimal decision. You may be surprised by some of the results – I know I was!
Example 1 – Making the Upgrade
You love your current car. It’s exactly what you want and fits your lifestyle perfectly. But, it’s got more than a few years and more than 100,000 miles on it. Your friends keep asking when you are going to upgrade to the newer model with its fancy new feature X. You read some reviews of the new model. Now you are rather pumped about its warming cup holders, so you decide to go for a test drive. You sit down with the salesman and he offers you an actual above-average deal: trade in your current car and walk away with the new one for $15,000. (Other assumptions used: $5000 down, 5 years @5% loan, which means a $189 monthly payment. Insurance and other fees for both cars are the same.)
Takeaway: The upgrade is not even worth it after 15 years despite 10 more MPG and half the maintenance cost. Are you thinking of upgrading to a new model? I can’t recommend it. (I even factored in a small benefit for the improved safety – still no dice!)
Example 2 – The Lifestyle Choice
You want to start camping, hiking, and skiing in the mountains year round plus you will be doing some big DIY projects at your home for the next few years. You realize you’ll require a bigger vehicle than your current sedan, but want to stay reasonable. You comb through some used pickups and find a bargain on a 2012 for $25,000. You secure loan approval for 6 years at 3% APY, $304 a month. You can sell your current car for $5,000, so a loan for $20,000. Let’s run the numbers again assuming insurance, fees are equal. (Again to keep it simple.)
But what if you just keep your current car and rent a bigger vehicle when needed. I added that extra cost into this calculation. It’s about 300 per week (plus gas) to rent a truck-like vehicle. I even went REALLY heavy some years to jack up the rental price and make this a “fair” game.
Takeaway: Again, not outlaying that wad of cash you could invest proves the better choice. Unless your lifestyle demands a big ol’ vehicle every day, it just cheaper to borrow when needed. However, in this situation, the difference is pretty close. Depending on how much you value convenience, sometimes a lifestyle vehicle is worth it. You’ll have to judge that for yourself. (Same can apply to buying too much house!)
Example 3 – The BIG Repair (closest to my Prius decision)
This is a very common scenario. You are face-to-face with a jumbo repair bill to get your current car up and running. Let’s say something like a transmission, and it’s going to cost you $3,500 on top of your normal yearly maintenance. Should you do it?
I more or less modeled this after my car purchase last July, when I moved on from the GTI into a Prius Plug-In. Three big factors helped me get there. 1, I was taking on a longer commute with a decent amount of travel time (using my car) so MPG could be a factor. 2, The GTI had been requiring lots of repairs and I didn’t see an end in sight. I was no longer doing my own work because of time, so the cost was higher than if I did my own work. 3, Owning a second car my wife could drive in case of emergency was worth a little extra cost.
So here is the scenario. Bump from about 25mpg to 55mpg, lower maintenance short-term and long-term, a bit of benefit for safety.
Ooh… how interesting! This situation begins to make sense for a purchase sometime in that 8th year. Seeing as how I plan on owning my car for longer (Prius last a looong time) I took the plunge.
Takeaway: A multitude of factors need to line up for a new-to-you car purchase to make sense. In my case, there were many factors that lined up nicely. EVEN SO, it will take EIGHT years to come out ahead.
Example 4 – The Zero-Car Lifestyle
What if you could design your life so you would not even need a car? If you live near a city, or are lucky enough to work from home or reside within a small community – you can likely make the switch. So let’s take a look.
You currently own a car, but only drive it on weekends for long trips. For the rest of the week, it just sits in a free parking space. Not bad. But, let’s say you sell your car for $15,000 and instead ride share on the weekends when you need a vehicle. You still drive the same number of miles and pay for gas. But, you have no maintenance, improved MPG, and of course 25 grand in your brokerage account. Let’s also assume the market is on a tear and you’re getting 10% returns EVERY year.
WHOA! I am actually a bit surprised at this. But really, maybe I don’t have a firm grasp on ride sharing and rental costs. By my investigation, you’re looking at about $500 a month for 8 days of driving, plus gas. Seems steep – I will need to keep looking into this one. (Please comment on this!)
Example 5 – You Don’t Own, But Will Need To
Finally, say you just graduated and are looking to start from scratch. You know you can afford a car up to $25,000. You get a great loan offer at 2.5% APY for 5 years, but have $0 to put down. You really want that newer model, but everything you read online tells you to spend between 10-25% of your gross income. So the question is: buy an older, slightly less efficient, higher maintenance car for $7,500 OR the newer more efficient, lower maintenance car for $17,500? (Assuming equal insurance, fees, and 5% market returns.)
Takeaway: Not too surprising that the cheaper car wins out. That time value of money is hard to beat. Once you get over those first five years of auto loan payments the gap begins to shrink, but not by much. You’re looking at being about $5,500 dollars head after 5 years, and still $3,000 after 15!
Again, it comes down to your budget, your lifestyle and your decision. I am just here trying to show you a variety of scenarios to get your mind thinking about approaching this purchase with logic and not emotion.
The Car Buying Workbook
I hope that sharing this works – I have never shared a Google document like this before. Nevertheless, you can find my workbook right here: zencents – Car Buying Workbook.
You should be able to view it. To edit, you will need to make a copy before doing so. I plan to update this over the months to make it more user-friendly, so check back if you find this useful. I know it is a bit messy right now.
I would really like to turn this workbook into a useful tool, so I would love some comments requesting new features or fixes you would like to see implemented.
So what did we learn from this exercise? Well, one – it’s really hard to justify any car purchase when you already own a working car. Unless you have a total rusty bucket, and its unsafe or REALLY not fitting your life, then even large repairs make long term sense. Polish your rust bucket and keep driving.
It’s really, really hard to justify a truck or SUV. Unless it’s for daily commercial use, I just don’t think anyone needs one. (Maybe you live on the side of a cliff, in which case getting your driveway fixed might be better long term solution!)
When buying a new, without ever owning, then don’t be too swayed by mpg, features or even maintenance costs. Cars are so iterative over the past 20 years that cost is the most important aspect when you are considering your long-term financial goals.
I realize there is a minimum entry fee for a decent car so that you don’t end up with a total bucket. For most people buying at that minimum is where you should start and end your search. If you are capable of quantifying your enjoyment, comfort, safety for the extra features then go ahead and justify your purchase. You know your emotions better than anyone. But remember to approach the situation logically in equal or greater weight.
How do you approach car buying? Any tips or rules you always follow?