How expensive car should one buy relative to income?

By May 18, 2017 Trading 2 Comments

2015 data suggests for every 1000 people India has just 32 passenger vehicles, a number that is abysmally low and makes it one of the most attractive markets for automobile manufacturers. More than 2million cars were sold in 2015. India has been growing for more than 7% in terms of real GDP for the last decade and with rising incomes car ownership percentage has been growing too. The car you choose is widely regarded as an expression of your identity, reflecting your priorities and revealing your status. Car companies have been selling this dream of “a happy family in a car” in almost every advertisement. So how much should one put in a car is the question.

Car is a depreciating asset in terms of accounts and finance and hence should be looked at as an expense instead of an investment over time. Also, one must pay maintenance and insurance costs over time which further can be a drain on income. One should be aware of these two facts before purchasing a car. The utility of car is unquestionable as a mode of private transport and the convenience it offers. Often commute and travel are daily hassles of a family and hence cannot be ignored. All this is now changing with the advent of ride-hailing service companies like Uber and Ola. With changing times the financial calculations have changed because people are starting to get an alternative for car ownership.

Also Read : Does Buying a Home Score Over Investing in Stocks?

The car ownership calculation should be based on two factors, one utility and other as your infatuation or love for car ownership.

Mathematics should be used to solve problems like these.

  1. Let’s say you buy a car of INR 6,00,000
  2. Insurance costs: INR 10,000 annually
  3. Maintenance costs: INR 20,000 annually
  4. Fuel spend: 5,000 monthly
  5. EMI on 5L@10% for 5 years costs you monthly 10,000
  6. Total costs approx. 2.1L annually (excl. depreciation)

So, a monthly budget of around INR 18k should be set aside for car ownership in the above case. Assuming a family wouldn’t want to spend more than 20% of income on car the family income should exceed 90k/month.

Based on the above calculations, a family earning nearly 12L/annum should at best go for a 6L car and so on. A family with lesser income should go for a lower priced car and family earning higher can still afford to pay higher. All these calculations highlight an example and are an attempt to put the calculations in perspective. An individual family might have different preferences.   

A different perspective of a value investor who lives like a miser, saves and invests in into value oriented companies and even generates an index like returns will stand to make around 14% per annum on the additional savings that he or she does. The 14% is the long term returns of investing in Indian benchmark equity indices and may differ for certain 5-year periods or in future. But still, assuming instead of spending 18k on a car in the example above one uses public transport or any other means of commute and finds a way to save additional 10k per month for the 5-year period. At the end of 5-year period he would have an additional corpus of 8.61L in his or her bank account. Just an additional 10k foregone every month will result in a sizeable corpus at the end of five years which could come in handy for your child’s higher education or family’s healthcare needs.

Also Read : Fixed Deposit v/s Equities – Which is better?

These calculations are shown to make a person realize the power of compounding and incremental benefits of saving over a long period of time. Obviously, a person saves and compounds money over time to have a better quality of life, one of which is owning a car and having the comforts that come along with it. But the point here is to analyse and assess whether such a big outlay is necessary in modern times where the largest startups are following an asset-light ownership model to increase returns, take the example of Uber and Airbnb. At an individual level, it is even more important to be aware of our expenditures and finances so that we make a calculated move.

So, before you go ahead and buy that expensive car maybe to show off to the society think again of what else could you buy with compromising on a cheaper one and whether those extra bucks in your bank account are worth more.

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