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
Interesting formula. Thanks for sharing. I’d be curious to see any widespread usage of this and how it might have guided decisions.
I’ve seen other formulas based on income, like you should buy a car that’s worth no more than 25% of what you earn in a year. I think that’s silly though. We should spend money based on our needs and relative wants first. If income took priority then it would be hard to save any money lol.
Interesting. My number is $45,000. I feel so cheap now, having bought a used $10,000 car a couple years ago. Not sure whether chicks would love it, but it moves me around comfortably, safely, and reliably, which is all I expect from my vehicle… 🙂
Wow, you probably drive a lot more than I do. My car was bought used for $10,000 as well. I’ve had it for 7 years now. I recently had to change its battery but it hasn’t given me any problems. The formula is only a starting point but of course we don’t have to follow it. It sounds like in your situation the $35,000 you saved by not buying a $45,000 car was the right move.
Interesting formula. Where or how did you come up with it? I’ve never seen this one before. At least if I have I’ve forgotten all about it. Would you mind if I share it in a future post I’m planning on making a first car purchase?
I wanted to create a simple way to determine how much we should spend on a car. Using economic utility factors seemed like a reasonable option. I basically want to ask how much is a car worth to me relative to other tangible goods that I’m willing to spend money on. The (s) variable is necessary to derive the overall value of our spending. This lets us figure out if we have the means to buy a car or not. For example, if our living expenses is only $500 a month just to make ends meet, then the formula will tell us maybe we shouldn’t be thinking about buying a car at all. If time is money, then the (h) variable is a good way to quantify that. For example, on average we might spend 15 hours at home, and 1 hours on the road per day. The rest of the time we are probably at work. That means 1/15 of our lives is spent in the car relative to time spent at home. So if someone is willing to pay $750,000 for a house, then buying a cheap $2,000 beater car to drive doesn’t make much sense. We should… Read more »
It’s true that if you live in a big metro area, driving might not be right for you. Unfortunately in Texas we don’t have a robust public transportation system, so cars are the go-to here. My idea is to spend as little as humanly possible on a car–and always buy used, with cash. We’ve financed cars in the past and still have a car payment, but cash really is the way to go.
I always buy used as well.
Interesting formula! I get $10,000 by using the formula, which makes sense. I don’t have a car anymore, but I’ll probably use this guideline for a vehicle in the future!
That sounds reasonable. You can get a pretty sweet car for $10K. 🙂
the correct amount to spend on a car is exactly $35000 USD (plus options) 🙂
there’s a bit of a waiting list though…
I paid $26k 13 years ago (over 40% of my annual income at the time) and it has proven to be one of the best purchases I’ve ever made. borrowed and paid it down over 4 years.
I say buy quality, and buy a car you’ll feel great about getting in to each day. Then maintain it to the highest standard and keep it for at least a decade.
it’s a personal thing though. if there’s no car that will give you that feeling then go for straight economics I guess.
The wait should be worth it, especially if more charging stations are available in the future.
If you’ve got the millions, I think the ideal is to have 2 cars:
1. An every day SUV for outdoor trips, going to random places, etc.
2. A sick super car for weekend drives down at the track and going out with girls
That would be ideal. I don’t got the millions yet though.
This is an excellent formula. I like how you incorporated the hours per month spent on a vehicle. This opens my eyes up a bit.
Though I am curious as to why you have insurance in the variable? For youngsters, insurance is going to be extremely expensive. I recall that at the age of 22, I was quoted a $300 per month insurance premium by ICBC (for a 2005 Acura RSX Type S). 10 years later, my payments were $125 per month. Which means that higher insurance premium will lead to one purchasing a more expensive car which is precisely the opposite of what it should be. Am I missing something?
Hi Revol. You bring up a good point about expensive insurance for younger drivers. I think insurance should be a variable to determine the cost of car ownership but you are right. I did not put it in the right place. Maybe having the insurance number outside of the brackets as a deterrent variable would be better. For example Price to pay for a vehicle = 0.01 x (monthly household spending) x (10 x hours driven per month) – (10 x monthly insurance premium.) It’s still not the best equation to use but it should be better. Let me know if you have any suggestions. Thanks.
[…] Interesting formula from Freedom Thirty Five Blog – how to budget for a car. We have no car payments now. It feels great. A future goal is to pay cash for our next car, striving to spend under $10k for it in 2018. […]
Eeeks I’ve always overspent on my cars. I filled in your formula and got $6030! I spent 4.5x on my new RAV4 but I get 0% financing over 3 years and I’ll be keep this one for more than a decade. Last time, I bought my Civic for $23k but I drove it a lot more and sold it for $5900 after ten years. I’m happy to upgrade to keyless entry and a/c plus all the newer options that comes with the RAV4… no regrets 🙂
The RAV4 is a popular vehicle for small families. 🙂 Lucky for me the 2007 model of my car already has keyless entry and a/c so I should be good for another few years at least.