How much of your networth should your car be? There is no law, but a widely used rule of thumb says a car should be a small slice, often ten percent or less of your net worth, and the cost of owning it should fit comfortably inside your income. The reason is simple: cars lose value, so money tied up in one is money that is shrinking.
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Why a car is a different kind of asset
A house may rise in value; shares often do; a car almost always falls. A new car typically loses roughly a fifth of its value in the first year and a large share over five years, according to depreciation studies by sites such as Edmunds. So a car adds to your assets on paper, but it drags your net worth downward over time.
Three rules of thumb
The net worth rule
Many advisers suggest keeping the value of your car to around ten percent of your net worth, or less. If your net worth is two hundred thousand dollars, that points to a car worth around twenty thousand. For people with low or negative net worth, this rule does not work, so the income rules below matter more.
The 20/4/10 rule
This guideline suggests putting down at least twenty percent, financing for no more than four years, and keeping total transport costs, including loan, insurance and fuel, under ten percent of gross income.
The half-your-income rule
Some personal finance writers suggest that the total value of all your vehicles should not exceed about half your annual income. If you earn sixty thousand dollars, that means a limit of thirty thousand across all cars.
A worked example
Suppose you earn seventy thousand dollars a year and have a net worth of eighty thousand. A car costing forty-five thousand would be more than half your net worth and over half your annual income, which breaks every rule above. A car at fifteen thousand would be under twenty percent of net worth and about a fifth of income, which is sensible. If you finance it over four years at a moderate rate, the monthly payment would be manageable, and you would build equity before the car loses most of its value.
How much of your networth should your car be if you are early in life?
Early-career people often have little net worth, so the percentage rule can look harsh. In that case, rely on the income-based rules and focus on reliability over image. A used car that is a few years old has already taken the steepest part of the depreciation. Choosing one can save thousands, which can go toward debts or savings that raise your net worth instead of lowering it.
Costs beyond the price
- Insurance, which varies with age, location and the car.
- Fuel or charging.
- Maintenance and repairs.
- Registration, taxes and parking.
- Interest if you finance.
Add these up before deciding what you can afford. A cheap car that breaks down often can cost more than a slightly pricier reliable one.
Lease or buy?
Leasing lowers monthly payments but leaves you with no asset at the end. Buying costs more per month but you own something afterward. If you drive many miles or like to keep cars long, buying usually wins. If you want a new car every three years and have steady income, leasing may fit, but read the mileage and wear terms.
Track the effect
The clearest way to see what a car does to your finances is to calculate your net worth before and after. Our guide on how to calculate net worth shows how, and our article on what net worth is based on explains how vehicles are valued. If you are comparing your position with others, see how high the top one percent’s wealth is for perspective.
Quick questions
Is ten percent a hard rule? No, it is a guideline.
Should I count a car loan as a debt? Yes, in the liabilities column.
What about luxury cars? They depreciate fastest, so they hurt net worth the most.
Where to read more
Edmunds publishes depreciation data that shows how quickly cars lose value.
In short, how much of your networth should your car be: aim for around ten percent or less, and keep running costs within your income. This article is general education and is not personalized financial advice.
Featured image: Car showroom, Sticker Lane – geograph.org.uk – 2248223.jpg by Humphrey Bolton , CC BY-SA 2.0, via Wikimedia Commons.
