The general problem
What car should I buy? This is a typical question at a time when owning a car has become a status symbol. Every day we can see ads that offer 0% down 0% APR car leases. Most of the ads are designed to target peoples’ desires and boost consumerism. As a result, many people (especially the middle and the lower class) often buy luxury items to look rich. They look rich, but in reality, they just get deeper in debt and further from building their wealth.
Buying an expensive car is one of the easiest mistakes one can make. Not only the purchase price and the running costs can be costly, but by buying an overly expensive car you lower your chances of building your wealth.
A friend of mine recently bought a car that costs 60% of her annual net income (excluding the running costs). She used all of her savings, borrowed money from parents and maxed out her credit card to make the purchase. Even though she is likely not to miss any payments due to a stable and highly paid job, it is hardly a rational decision.
How I bought my first car
When I was 22 years old I decided to buy my first car. I had recently graduated from university and got my first job as a financial consultant. I didn’t really need a car, but at the time I told myself all the typical things to justify the purchase and thought it would be a good decision (I was also the victim of consumerism).
I also had a stupid idea of buying a flashy car on a lease that shows “my success in life” or more like lack of financial knowledge. When my friend bought a VW Polo, I laughed at him. I was not thinking rationally and didn’t consider the impact on my wealth of overspending money on a car.
Luckily, when I went to a car dealership, they refused to give me a lease. My hopes of getting an expensive car with a massive monthly lease (roughly 50% of my monthly salary) were crushed. I finally asked myself a question – what car can I really afford with my savings and current salary? I started thinking about insurance costs, maintenance costs and fuel economy. After some research, I bought 2007 1.4 TDi VW Polo, which I laughed about couple of years earlier.
Buying a luxury on credit often causes a person to eventually resent that luxury because the debt becomes a financial burden.
What it’s like buying a car below your means?
I bought the VW Polo 5 years ago and still drive it today. Since the purchase date, it has lost roughly 40% of its value (depreciation of $320 per year). By having no car lease and no other major debt, I was recently able to buy a condo close to my work. I managed to save up enough for the down payment with some extra left for emergencies as well as other investments and business ideas.
Buying a car below my means has also saved me lots of worries. I have no stress when parking my car in a dodgy neighbourhood. I don’t worry too much if someone has scratched my car or broken a mirror, which happened this week (see picture below). Most importantly, it costs me very little to do these repairs and I have extra money to invest and build my wealth.
The graph below is a good example of how my purchase has made me feel. I was excited when I bought my first car. Then I was envious of others who had better cars and my happiness went down. Now I am happy that I didn’t overspend on a car and was able to use the money elsewhere. My friends who bought more expensive cars have sold them incurring losses or kept paying large leases, crippling their budget and foregoing opportunities to invest.
What to do if you already bought a car you cannot afford
Everybody makes mistakes from time to time. Once you have recognized your mistake, you have to start fixing it. Some ideas I have listed below:
✓ Suck it up, deal with the car payment, and drive the car until it dies: If you really like the car and the lease payment won’t completely destroy your budget, then one option is to drive the car as long as it is safe. This is the simplest solution if you have spent too much on a car. Meanwhile, your income should be growing and if you keep the car for 10 years or more, it will eventually become affordable to you.
✓ Sell the car, buy a cheaper one, learn from your mistakes: An important difference between the upper class and the middle/lower class is that the upper class buy luxuries last. The middle and the lower class tend to buy luxuries first. Even if you incur some losses on the sale, I think it’s worth getting rid of your expensive car. Then buy a “budget” car which meets your basic needs without spending any more than necessary. This way you will feel much better in the long run.
At the end of the day, it is important to recognize your mistakes and then learn from them. Otherwise, you will keep making them all over again.
Your car is not an asset
It is important to understand what is an asset so that more people invest in assets that create wealth rather than destroy it. If you ask an accountant, she would say that a car is an asset, because that is how it is classified in a company’s financial statements. If you ask for the definition of an asset, the typical answer would be – An asset is something that appreciates in value, keeps your money safe and/or generates income. Now, if we look at a car, it doesn’t generate income (unless you drive an Uber or run a taxi company), it doesn’t appreciate in value nor does it keep your money safe.
Typically, your car loses value the moment you drive it off the lot and continues to lose value as time goes on. It also has other costs, such as fuel expense, maintenance, insurance etc.
Even though cars have monetary value, they aren’t your assets. Everyone who wants to grow their wealth should think about buying cars which meet their basic needs and are cost-effective, without spending any more than necessary. If you save money on your car, you should be able to afford some real assets and create wealth.
Buy an expensive car or build wealth?
The choice is yours!
On the one hand, you can buy an overly expensive car to satisfy your desires and pretend to have “success in life”. You will have an expensive “asset” that consumes your money, prevents you from building wealth, at the same time losing its value. If you wanted to upgrade to a newer car, you would likely go into more debt or work more for the money, resulting in more stress. In the end, you are more likely to feel regret than happiness by spending a great share of your money on a car.
On the other hand, you can buy a car that gets you from A to B within your budget. By doing so, you will have less stress and more money to invest elsewhere. This will allow you to increase your income and eventually you will be able to afford much more. Start thinking how today’s financial decisions affect your future and you will be more likely to achieve your financial as well as non-financial goals.
First build wealth, then buy luxuries!