•Avoid payday loans!
CHAPTER SIX
MINIMIZE YOUR CAR EXPENSE
THE TRUE COST OF COMMUTING
I purchased my first car when I was 27. I know, I know: How could I get around without owning a car? And, what about dating? Coming out of undergrad making $40,000 a year, I could not justify it, and if a girl is only dating me because I have a car, that is not a good sign. I also had $10,000 of student loans that I needed to pay off, and it was a minimum 45-minute commute to downtown. I knew that the average person’s car costs are $8,000 per year, enough to make the difference between debt and comfortable riches over time, and the fact that owning a car can be the biggest financial mistake people make. Instead, I took the bus and train, but what I should have done was move closer to work because I was not aware of the true cost of commuting.
In my scenario, driving 10 miles (16 kilometers) to work and back amounts to 20 miles a day. The government estimates the total cost of driving at $0.51 per mile, which adds up to $10.20 per day of direct driving and car ownership costs. It is possible to drive for less—likely these cheaper-to-run cars are newer, with less maintenance costs, have higher fuel efficiency, and most likely bought on credit.
At 90 minutes per day, the driving would add almost an entire work day each week. I would be like “working” 6 days a week. Flash forward 5 years, this would amount to $13,260 and 81 days spent driving.
Minutes driving=
90 minutes x 5 days x 52 weeks x 5 years= 117,000 minutes
Days driving=
117,000 / 60 minutes / 24 hours= 81.25 days
Driving cost=
$10.20 x 5 days x 52 weeks x 5 years= $13,260
In my case, it cost me $6,000 in transit passes, a difference of $7,260 that helped me achieve my savings goals. On the train, I listened to audiobooks and podcasts—over 500 hours of podcasts and 40 audio books. However, if I could do it over, and if you ever have the option, the better decision would be to move closer to work. If you take an hourly rate of $20/hour (~$40,000 a year), the true cost including the time cost would have been closer to $52,260.
Driving cost=
$10.20 x 5 days x 52 weeks x 5 years= $13,260
Hours driving=
117,000 minutes ÷ 60 minutes= 1,950 hours
Time cost=
1,950 hours x $20 an hour = $39,000
Total cost=
$39,000 + $13,260 = $52,260
Assuming you value your time at what you get paid, it is hard to justify a long commute.
REALITY CHECK ON NEW CARS
There are several popular reasons to buy a new car versus leasing or buying used:
1.New safety technology
2.Fuel efficiency
3.Low maintenance costs
4.Lower interest rates
All valid reasons. That said, I find it hard to justify buying a new car unless you are willing to own it for 10+ years and reap the benefits of no car payments in the final years of ownership. Even then, owning a used car is more appealing because you save money on car payments upfront rather than on the back end. Furthermore, if you buy a car that is three years old, for example, you still benefit from the latest safety technology and fuel efficiency without the high upfront cost. A car at that age likely will have low mileage. If you buy new, you are probably paying the car off over five to seven years. If you put that money into index funds instead of a car payment, you get a greater return. Through depreciation on new cars, you lose the most value in the first 50,000 miles, meaning this is when it is the most expensive time to own a car. Why not buy a used car with 50,000 miles already on it and invest the difference?
A new car on average:38
•Loses 10% of its value when you leave the lot.
•Depreciates by 15% to 25% each year over the first 5 years.
•Loses 60% of its total value over the first 5 years.
Why would you want to drive new when you can get a perfectly good used car and let someone else eat the depreciation cost?
BUY USED AND USE THE 10% RULE
If you can afford it, pay cash for a used car. When I finally made the decision, I bought a five-year-old used Honda Civic for $8,500. Cars in the $10,000 to $13,000 range are in the middle-to-upper range of the car market for most people’s needs. A rule of thumb is that if you want a safe and reliable car, then only spend up to 20% of your annual income on it. If you can manage, lower is better. So, if you make $60,000, then spend a maximum of $12,000 on a car. Personally, this is too high, so I recommend the 10% rule.
The 10% Rule
The 10% rule means that you do not pay more than 10% of your annual salary on a car. You are likely thinking, “I don’t want to drive a beater!” What about first impressions and showing off? Most people fall into this trap, which prevents them from becoming financially independent. Use this as motivation to make more money. With the 10% rule, if you earn $60,000 per year, then you are stuck driving a $6,000 car. So, think of ways to make more money. I talk about how to increase your yearly revenue in Part Two, Growth.
In all honesty, if you spend less than 20% of your gross income on a car, you are doing okay. Most people spend 50% or more. The median price of a new car is $24,000, so if you make $50,000 a year that is 48%. However, if you spend 10% or less, you are that much closer to financial independence. Even with this price restriction, you can find a reliable car that will last years, just do your research beforehand.
AVOID LEASING
Leasing a car looks like a discount compared to buying a new car, but it is terrible when compared to buying a used car. The number one reason? You do not own the vehicle. It is like paying rent on a depreciating asset. You pay the dealership the cost of the depreciation through your payments and penalties for mileage overage and wear and tear on the vehicle. Moreover, your insurance is likely higher, and if you are involved in an accident, you will have to pay the full lease amount. The benefit of owning a car outright is having zero payments and being able to put that money into investments.
WHAT IF YOU PAID TOO MUCH FOR A VEHICLE?
Everyone makes mistakes. The most important thing is being able to reflect, learn from it, and fix it. If you already bought an expensive vehicle:
1.Keep your vehicle until it becomes 10% of your gross annual income or less. This is the easiest solution if you have spent too much. Keep driving your car for 10+ years, and it will eventually become 10% or less of your gross annual income.
2.Take the loss and sell your vehicle. If you spent more than 20% of your gross income on a car, consider selling it if you are not willing to keep it until it becomes 10% of your gross annual income or less. The long-term costs of car payments, in conjunction with the lost opportunity cost of not being able to invest that cash flow, hurts you financially.
3.Use social media to make your mistake public. By making your mistake public, you own up to it. The last thing you want to do is admit you made the same mistake twice.
If you require a new car, look for cars that are at least three years old. Your depreciation and car insurance will be less for a used car and maintenance costs will still be low. It is also better to pay cash for a used car than finance it. Most of the 0% or low-interest offers for financing are for new cars. Used cars can have interest rates as high as 10%. That is cheaper than a credit card, but given the market, on average, rises 9.7% a year, you are falling behind.
RIDE SHARING ADVICE
When does ride sharing make sense and can you use it instead of owning a car? The answer is it depends on how often you need a car. If you need a car for your daily commute, then it is likely that owning a used car is cheaper than taking an Uber. According to the American Automobile Association (AAA), the average cost of owning and driving a sedan is $8,876 as39 of 2014, broken into six categories:
•Payments / depreciation: $4,260
•Fuel costs: $2,130
•Interest: $976
•Insurance: $887
•Maintenance a
nd repairs: $355
•Registration and taxes: $355
Uber
Say you drive 5,000 miles a year. According to the U.S. Federal Highway Administration, the average commute time is 25.5 minutes, and the average number of trips per year is around 500 (keeping numbers simple). Using the rates of $1.10 per mile, $0.21 per minute, and $0.80 per trip, we calculate the following fees.
Uber base fees=
500 trips x $0.80 per trip= $400
Mileage fees=
5,000 miles x $1.10 per mile= $5,500
Time fees=
500 trips x $0.21 per minute x 25.5 minutes= $2,678
Yearly Uber fees=
$400 + $5,500 + $2,678= $8,578
Monthly Uber fees=
$8,578 / 12 months= $714.83
Based on AAA’s average yearly cost of $8,876, using Uber at a cost of $8,578 a year is a better choice if you drive less than 5,000 miles per year.
Zipcar
An alternative to Uber is Zipcar’s Commuter Service where you receive a Zipcar from 5:00 am Monday to 7:00 pm Friday for a $249 monthly fee plus $0.45 per mile for the miles you drive. Parking, gas, and insurance are included in the membership. If you drive 5,000 miles per year, this equates to $2,250 for the miles driven plus $2,988 for the monthly fees over the course of the year for a total cost of $5,238. This cost is much cheaper than Uber for the same distance. In fact, your commute needs to be 13,000 miles per year to match what the average cost of owning and driving a sedan is. Not a bad deal. The only caveat is the service is only in selected cities and does not include driving on the weekends.
Zipcar Commuter yearly fee (5,000 miles)=
($249 x 12) + (5,000 miles x $0.45)= $5,238
Zipcar Commuter yearly fee (13,000 miles)=
($249 x 12) + (13,000 miles x $0.45)= $8,838
MONEY-SAVING TIPS
Most people do not realize that taking on a car payment is one of the worst things to do when trying to create wealth. The car payment is the largest cost after home mortgage/rent, so it eats up more income than pretty much anything else. The average car payment is $495 a month over 64 months, and once they pay off their car, most people take on another payment because the allure of having a new car is too much! Get out of this cycle and invest that money instead. Over 40 years, $5,940 a year saved becomes $2,658,575!40
If you need a car, follow these rules:
1. Never Borrow Money to Buy a Car
Smart, frugal people do not buy new cars, and they never buy on credit.
2. Buy a Car That Does Whatever You Need It for Most
Your default vehicle should be a car unless you use a truck for work, SUV for off-road excursions, or another vehicle where a car is inappropriate. Otherwise, the “what-if” scenarios of buying a different vehicle will cost you more money than it is worth for the few times you might use it.
3. Limit Your Driving
Many people believe if they are making payments on their cars, then they may as well use the car as much as possible since it only costs them their monthly payment. This is the wrong mentality. The more you drive your car, the faster it will wear out—tires, maintenance, gas, it all adds up. This is another reason why it is better to live close to work.
SAVE ON CAR INSURANCE
Shop around for car insurance. Get at least three price quotes and have insurers compete for your business. Ask friends and relatives for their recommendations. Also, look at insurance costs before you purchase a car. The last thing you want is an unplanned cost. When searching car insurance, keep these factors in mind:
•Do not shop by price alone. Look at other variables such as fuel economy, mileage, and what condition the car is in.
•Ask for higher deductibles, which can reduce your collision and comprehensive coverage by 15% to 30%. Have enough spare cash in your emergency fund to pay in case you have a claim.
•Buy your homeowners and auto insurance from the same insurer. Many companies give you a break if you buy two or more types of insurance from them. You may also receive a reduction if you insure more than one vehicle with them.
•Some companies offer reductions to drivers who obtain insurance through a group plan. So if possible, use your employer; professional, business, and alumni groups; or other associations.
SUMMARY
Remember, owning a car is one of the worst things to do when trying to create wealth. Ask yourself if you require a car or if it is a nice to have. Can you get by using other means?
•If you have a lengthy commute, move closer to your work. Less travel means you will be happier on average and save money on wear and tear on your car, gas, and your personal time.
•Buy used. Try to keep the cost under 20% of your annual salary, preferably 10%.
•Avoid leases.
•Try not to borrow money to buy a car.
•Determine if ride sharing is an option if you do not need daily transportation.
•Limit your driving to make your car last longer.
•Shop around for car insurance for the best deal.
CHAPTER SEVEN
HAVE INSURANCE JUST IN CASE
RECOMMENDED CRITERIA
I hate paying for insurance. I think to myself, “Why am I paying a premium for a ‘what if?’ scenario?” Some argue that insurance of all types—car, house, health, life—is a big waste of money. And in some cases, insurance is bought partly out of fear and without any consideration to whether it is a good deal. If you are an average consumer, you are likely spending thousands of dollars per year on various insurance. Is it a waste of money? Not if you are getting insurance for these reasons:
1.You are forced to have insurance, e.g., a bank requiring car or house insurance.
2.You cannot afford not to have insurance if something goes awry, e.g., with your health or if your house were to burn down.
3.You are riskier than the insurance company thinks you are, e.g., you drag race your car on the weekends or know you might be diagnosed with or are currently have an existing health condition.
All other insurance is arguably a waste of money. Extended warranties? Forget about it. Identity theft insurance? Credit card balance protection insurance? No way. Take the money you would have used to purchase those policies and put it into an index fund ETF, which I discuss in Chapter 10: Invest in the Index. Insurance companies know the odds are in their favor. Otherwise, they would be out of business.
When you buy insurance, it better be for the right reason. An accident or disaster could leave you in financial ruin in an instant. Do your research and avoid overpaying when you look for a policy.
1. Only Insure Against Things That Can Ruin You Financially
•Your house or rental unit
•Your car
•Traveling overseas and becoming sick
•Going to the hospital
•Death or permanent disability
•Being unable to work
2. Have High Deductibles to Save on Premiums
3. Negotiate Your Insurance Premiums Every Year
Many different insurance types and products exist. How do you know what you need coverage on and how much? It can be overwhelming, not to mention the high-pressure sales tactics that you may face when looking for a policy. As a general guideline, I recommend homeowner’s / renter’s insurance, car insurance, life insurance, disability insurance, health insurance, and travel insurance at a minimum. However, other types of insurance may also be essential, depending on your situation.
RENTER’S AND HOMEOWNER’S INSURANCE
A home is often our largest asset, so insuring it is essential to protect our net worth from unexpected disasters. Homeowner’s insurance covers the cost of rebuilding or making repairs to your home if it is damaged or destroyed by a disaster like a tornado or fire. It also covers the contents of your home up to a fixed dollar amount.
Renter’s insurance is just as important as homeowner’s insurance. Most renters do not realize that the landlord’s insu
rance will not typically cover personal property when damaged or destroyed. And, this policy is affordable, often cheaper than homeowner’s insurance.
Both policies offer some protection inside and outside of your home. If someone slips and breaks their leg on your property or your dog bites someone, your policy could cover the medical bills. And, coverage usually insures your belongings when you travel as well as offering financial protection from theft.
In most cases, flood insurance is not included in either policy. If you live in a flood-prone zone, I highly recommend buying a separate flood insurance policy.
Keep receipts and photos of everything for your records. Use the app of your insurer, if they have one, or a website like Sortly to keep a copy of your inventory online. Apps like Evernote, Google Keep, and Microsoft’s OneNote are also an option as they allow you to take a picture of an object, tag it, and store it.
Read the fine print of your insurance policy, too. Some insurers have a bad reputation of denying coverage for technicalities like only protecting against rising waters and not burst pipes. Read reviews online, check Consumer Reports, and do your research.
CAR INSURANCE
With car insurance, you want to protect yourself against collision and liability. In no-fault states in the U.S., you also need medical payments coverage.
Collision protects your car, and the level of coverage depends on the car you are driving. Insurance companies only reimburse you for the book value of your car, so if you are driving a $2,000 beater, then it might be worth driving without collision. Otherwise, I recommend full coverage for collision.
Liability insurance is the critical part of car insurance. Whatever you do, do not sign up for the minimum coverage. Liability pays the bills if anyone is injured in a car accident. If you do not have adequate coverage, your financial future could be in jeopardy. I suggest full coverage for liability.
Kicking Financial Ass Page 9