When I finally hit financial independence, I was still driving a 13 year old car that I loved very much. It was a Lexus IS300, and she was a beauty. But she was starting to give me fits. The air conditioner suddenly stopped working. The brakes started squealing. She had trouble passing the Smog check test every 2 years. And she was starting to get expensive just to maintain. The whole suspension needed to be replaced. Not to mention that the check engine and traction control lights were constantly on.
I started to have my doubts about her. It was finally time to get a new car. So how does an actual millionaire buy a new car? And how does someone who's striving to be a millionaire buy a new car? Is there such a guide that can help one to not overspend, so one can still have money leftover to invest? The millionaire's guide to car buying will show you how using the 20X Rule or 10% Rule!
Option #1: The 20x Net Worth Rule For Car Buying
A great barometer to determining how much to spend on a car is comparing it to your overall net worth. After all, if you can live in a free and clear $3 million mansion, and live off $150,000 a year in passive income; you're much better off than someone who earns $300,000 a year but have zero assets.
The 20x net worth rule is very simple. Take your net worth and divide it by 20 to get the maximum price of your new car. If you have a net worth of $2,400,000, dividing it by 20, you're able to buy a new car that cost up to $120,000. Maybe a Porsche 911 4S Targa is what you desire. Whether you decide to spend up to $120,000 or not is up to you. Maybe driving a Toyota Camry fit yours frugal nature while you're sporting a $2.4 million net worth! Or maybe a Lexus IS is all you desire even though you could certainly afford a car about 3x more!
If you're like me, then you probably agree that cars are so much fun! I understand every single one of you who wants the latest model sports car or a nice SUV. But cars are also the biggest money wasters in the world. Nobody needs a car that cost over $10,000, because all cars will get you from point A to point B regardless of their price.
The money we spend on cars should instead be invested to give you additional passive income annually. Things like real estate or equities will super charge your net worth and add passive income into your life. You should think of opportunity cost every time you are deciding on which car to get. Every time you are thinking about spending $50,000 on a new Mercedes, just think of how it could turn into almost $300,000 in 10 years (if it grows at 18% a year (highly achievable with investments such as commercial real estate)).
Millionaires always ask themselves if they are comfortable spending 1/20th of their net worth on a depreciating vehicle. Maybe they do, but that would be the max. Most millionaires will typically spend less than the 20x rule because they are more focus on using the money to invest.
Car Buying Examples By 20x Net Worth Rule
What if you're an aspiring millionaire? Are you forced to follow the 20x net worth rule? No, there's an alternative. The car buying guideline everyone else should follow (including millionaires):
Option #2: The 10% Income Rule For Car Buying That Everyone Should Follow
Buying too much car is one of the easiest and biggest financial mistake most people make. Besides the high purchase price of a car, you also have to factor in car insurance, gas, maintenance, tires, car washes, and any tickets you may get while driving or parking illegally. When you actually add everything up, you would be pretty shocked to see how much owning a car really cost! That money is much better used in investing in yourself, starting a venture, or investing for passive income. But I know you want a new car, so let's get to it.
The 10% income rule for car buying is very simple. Spend no more than 10% of your gross annual income on purchasing or leasing your new car. If you make $50,000 a year, limit your annual spending to $5,000 a year for buying a new car; that comes out to about $416 car payment per month when buying or leasing a new car. I personally would include the car insurance and registration yearly fee into the monthly total payment as well. So if your car insurance and registration yearly fee averages to about $100 per month, your car payment including taxes should not exceed $316 per month, based on $50,000 income.
Why You Should Not Spend More Than 10% of Your Annual Income On A New Car
If you want to achieve financial freedom and not have to worry about material things stressing you out, follow the 10% gross income or 20x net worth rule! If you don't care about being financially independent, and just want to end up working longer so you can impress other people: then go spend ABOVE what you can afford. You only live once right? All is gravy!