A Car Buying Formula
Someone once said that an old car is like virginity. Once you’ve had it for over 25 years it’s kind of hard to get rid of because nobody else wants it either. 😄 But I’m not here to give relationship advice. This is a personal finance blog after all. So in today’s post we’ll discuss one of the most common questions people face; how much is appropriate to spend on a car? For most people I would recommend the following formula.
0.01s(5h+2i) = Price to pay for a vehicle
s = Monthly household spending (before accounting for the potential vehicle.)
h = Number of expected hours the car will spend on the road per person per month.
i = Monthly cost of the auto insurance.
For example, I live pretty close to work so I only spend about 20 hours on the road each month. My car insurance costs $100/month, and my monthly household spending is roughly $2,500. When these numbers are plugged into the formula we see that I should spend about $7,500 if I were looking to buy a car today.
0.01 x $2500 x (5 x 20 hrs + 2 x $100) = $7,500
Let’s look at another example. Susan and Bob are looking to buy a vehicle. It will be used primarily for Susan to drive to work, but will also be used for shopping / recreational activities for both of them. They estimate the car will be on the road for 50 hours per month. They will be in the car together for 10% of that time. Their monthly spending is $3,200. Insurance for the car is expected to cost $150/month for the type of vehicle they are looking for. Using these numbers we discover they should budget in the range of $18,400 for a car.
0.01 x $3200 x (5 x 55 hrs + 2 x $150) = $18,400
Even though the car spends 50 hours on the road, we are using 55 hours in the formula. This is because two people are expected to use the car simultaneously 10% of the time so during those times the hourly rate of utility is doubled.
You auto know, the formula in today’s post is the wheel deal. 😀 This way of evaluating how much to pay for a car takes into consideration the vehicle’s economic utility, as well as the relative expense it will cost respective to a household’s spending habits. For example, if Susan and Bob plan to use their car twice as often as suggested above their result would increase from $18,400 to $27,200. If they spend more time in their vehicle they should invest in a more comfortable ride.
Also keep in mind this formula doesn’t tell us how much car we can afford to buy. Its purpose is to help determine the optimal price range to achieve a balance between pleasure and cost. It’s simply a guideline. It would be perfectly reasonable to add or subtract up to 50% to the calculated value depending on how much the individual knows about and appreciates cars.
As with any financial forecasting there will be assumptions made. Here are some suggestions to fill out the formula if you’re stuck. For (i) ask an insurance broker for a quote or a friend on what they pay for their car insurance. Note that this number can always be revised based on the outcome of the formula. For (s) simply track all your spending for one month. I assume you’re doing this anyway if you’re a regular reader here. Tracking your finances is the first step to early retirement. 🙂
Of course there’s also the question of whether driving is right for us in the first place. This can depend on many factors. For example, I would probably not want to drive in a city such as Tokyo where public transportation is convenient. Choosing to finance/lease/cash is another consideration but that’s a topic for another time.
Random Useless Fact