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Last week I wrote about how your car is making you poor. It has generated a good discussion so I wanted to expand on it a bit more and give everyone an opportunity to talk about how much they pay for their vehicles on a monthly basis relative to their income. It should be interesting to see how the answers vary and see what people are doing to help keep their vehicle costs down.

I’ll start with my own situation to kick things off. Right now our total monthly vehicle costs total about 9% of our monthly net income. This includes car payments, insurance, and gas. I added about $25/month to that to account for regular maintenance such as oil changes and annual registration fees. I feel that 9% is pretty good, but I was actually shocked it came out that high. When I started to factor in everything in addition to just the car payments it added up pretty quick.

Even so, there were a few key things we did to help keep our overall costs down. First, we had to buy two vehicles a few years ago. My clunker at the time finally died and my wife needed something a little more practical for getting around. So, the biggest thing we did was bought two used cars. Just gently used and only a year or two old, but it still saved thousands over buying new.

Next, we picked vehicles based on our needs. I have a long commute so a car that gets reasonable gas mileage. My wife on the other hand only has a 5 minute commute to work. So in her case we didn’t have to focus so much on gas mileage so we got something a little bigger that could handle the tremendous snow we can get and accomodate hauling an occasional trailer or kids.  So while I might burn through $100/month in gas, my wife can go weeks at a time without filling up.

Finally, we make sure to shop around for the best insurance. In addition to just finding good overall insurance we also knew better than to get a policy with a low deductible since that adds significantly to the premium. So by finding a good policy with a reasonable deductible and coverage options we can keep our premiums down to a reasonable level.

So, what about you? How much of your income goes toward vehicle costs? Did it come as a surprise when you figured it out? And how do you keep your costs down?

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This country has an obsession over cars. It sort of makes sense considering how most of our cities are laid out and the desire for suburban living basically requires almost everyone to not only own a vehicle, but to spend a considerable amount of time in it while going from place to place.

While just having a car isn’t a bad thing, most people don’t fully realize how much of their wealth is getting flushed down the drain while owning a car. They are expensive, depreciate in value rapidly, you have to regularly fill them with gas, and insure them. That really starts to add up.

A Typical Cost Breakdown

So, just how much is that car costing you? Let’s take a look at a typical vehicle and scenario that would fit almost any middle class American household. We’re going to use a new Toyota Camry and these sell for anywhere from about $20,000 - $30,000 depending on features and your location. So, we’ll shoot for something right in the middle of the pack and assume for this example that someone finds one for $25,000. And let’s not forget about sales tax since that’s going to apply to most people as well. 6% is a fairly common state sales tax rate so if we tack that on to the price of the car we have a total sale price of $26,500.

It really doesn’t matter what kind of car we’re talking about or even whether it’s new or used. What’s important is the actual price paid.

Financing

Now let’s talk financing. Most people don’t pay cash for their new car and will typically finance it for somewhere between 3 and 5 years. In addition, most people don’t put a significant down payment down or will trade in their old car. For the sake of this example we’ll assume that we’re putting $5,000 down or getting $5,000 for a trade. That means we’re left financing $21,500, and let’s shoot for a 48 month loan. Rates on this type of loan right now are averaging around 7% so we’ll go with that. That ends up adding $3,200 in interest payments over the life of the loan and a monthly payment of about $512.

Insurance

Insurance is going to vary depending on a lot of different factors. The deductible you choose, your driving record, age, state, and so on. So the best we can do is ballpark an average rate for this type of car. Just keep in mind that you may be paying quite a bit more or even less depending on your situation. Running some quotes and looking online the annual insurance premium on about a $25,000 sedan will cost roughly $1,200 a year or $100 a month.

Gasoline

Every car needs gas, and gas can be expensive. Luckily for this example we have a car that gets decent gas mileage and it’s rated for roughly 20 mpg city and 31 mpg highway. We’ll average it out and assume an overall mpg of 25. The average person drives 12,000 miles each year. Obviously, your own driving habits may differ. But at $3.00 a gallon that would mean you spend $1,440 a year or $120 a month on gas.

Maintenance

Cars need a little TLC and you will need to spend a little money to keep it running its best. The most common maintenance item is the oil change. At a quick lube place you can expect to pay around $30 for an oil change and you’ll likely need 3 of them a year. You’ll also probably need a few other odds and ends like new wiper blades, car washes, etc. So we’ll allocate another $50 a year to cover those miscellaneous expenses. Regular maintenance costs are going to be around $140 a year and you can probably expect to pay about $100 or so on annual vehicle registration.  Just to keep things simple, we’ll call these miscellaneous expenses $20 a month.

Total Monthly Breakdown:

• Car Payment = $512
• Insurance = $100
• Gas = $120
• Maintenance = $20
• Total = $752

It’s amazing how fast that adds up, isn’t it? We’re talking $750 a month just to drive a middle of the road sedan. And that’s with a 20% down payment, a good credit score that gets you a decent interest rate, and a clean driving record that keeps your insurance premiums down. Just imagine if you can’t get a rate for 7%, don’t put any money down, or your insurance premiums are nearly double because of a few tickets on your driving record. You could easily be approaching $1,000 a month. If you earn $40,000 a year you’re spending nearly 25% of your gross income on a vehicle that only decreases in value each year that you own it.

Multiple Vehicles and Luxury Cars

In that example we just used a modest no-frills sedan and look at the true cost with that. Now, think about needing two of these cars because you’re married and you both work. Now you’re making a mortgage size payment just to have something to drive you around.

And what if you’re driving a luxury car or SUV that comes in at $40,000 or more? You can expect your total monthly costs for just one car to easily exceed $1,200. If you need two of these more expensive vehicles you better be prepared to shell out close to $3,000 a month.

Car Costs vs. Saving

I help people with their finances every day. That’s my job. That means I usually have to spend some time digging into a person’s finances to help uncover problem areas or opportunities. If there is one thing that I see more than anything, it’s people who are spending more on their vehicles than what they are saving for retirement or otherwise. Without fail, whenever someone says they don’t have any extra money to put into their retirement account or into a savings account, you can almost always count on significant car costs when digging through their monthly expenses. Whether it’s $300 a month or $700 a month, they can make those payments each month yet can’t scrape together $100 to put into a savings account or their retirement account.

Here’s a rule of thumb: if your total car costs exceed what you’re able to save, you have more vehicle than you can afford. That means if you’re paying $500 a month to keep your car on the road yet can’t come up with $500 each month to stick in your savings or retirement account, you’re in trouble. You will never build the wealth you want by throwing more money away on a vehicle than you can save or invest. That money you apply to a car payment, gas, insurance and everything else doesn’t come back. You do not make money and it is not an investment.

At the same time if you can afford to spend $1,000 a month on your vehicle and still save $1,000 a month, that’s great. Sure, you could still save more money if you cut down your car costs, but at least you are matching every dollar that goes out and putting it into something that is an asset and an investment. At the bare minimum that is how you need to look at it. You have to at least be saving as much as you’re spending.

How to Make Sure Your Car Doesn’t Make You Poor

As you can see a car can make you poor pretty fast. The costs add up and if you’re spending more money on a mode of transportation than what you’re setting aside for the future it’s going to take a long time to build wealth. Unfortunately, most of us need a car. That’s just the reality of it all. But you can take some steps to make sure that you’re keeping your car costs as low as possible so that you can focus on building wealth, not just maintaining a vehicle year after year.

Used vs. New

It goes without saying, but a used car is going to save you money. Remember, cars depreciate in value, often as much as 20% each year. If you can buy a used car even just a year old you could save thousands of dollars which translates to less interest when financing and a lower monthly payment.

If you are looking at a new car, that’s fine too as long as you plan on owning the car for a long time. When you get into trouble is when you keep buying a new car every 3 or 4 years without paying off the first one, or just barely paying it off before buying a new one. This creates a vicious cycle of constantly spending more than you need to. A new car can be a good deal if you know that you’re going to keep it well beyond the financing terms.

Size Matters

The larger the vehicle, the more it costs. Smaller cars are generally cheaper than full size cars, and cars are usually cheaper than trucks or SUVs. So, only buy as much car as you really need. Your situation and driving needs will dictate what kind of vehicle you need, but don’t go overboard.

As you increase in vehicle size and price, you’ll also typically get increased insurance premiums and fewer miles per gallon as well. So, there is more to size than just the initial cost. The higher costs often trickle down to all other areas and it will really start to add up fast.

Consider Depreciation and Maintenance

Not all vehicles are created equal. Some cars will hold their value over time better than others, and some cars have notorious maintenance issues. Do your research before buying your next car and don’t just buy something because it looks good in the commercials. You can not only save some headaches down the road by picking a reliable car, but if it retains its value you will take less of a hit when it comes time to sell.

Finance Wisely

If you need to finance your car purchase, be smart about it. Yes, you can keep your monthly payment low by stretching out the loan to 5 or 6 years, but you aren’t doing yourself any favors. All you’re doing is paying more interest on something that continues to decline in value. Would you borrow money at 7% interest just so you could invest it in a stock that was guaranteed to drop in value by 15% each year? Of course not, but that’s what you’re doing when you finance a car purchase. We know that the value of the car is going to go down each year, so the sooner you can pay it off and the less interest you pay, the more you ultimately save.

You Are in the Driver’s Seat

It’s up to you to decide how you want to spend your money. A vehicle may be a necessity, but it doesn’t have to negatively impact your financial future. If you aren’t careful, a vehicle can erode your wealth faster than anything else, but with some smart decisions you can make sure that it doesn’t.

Be smart about your vehicle costs. It might be nice to drive around in something a little fancy but is it worth the negative impact it may have on your long-term financial goals? That’s for you to decide.

Has Our Retirement System Failed or is it a Problem With Expectations?

There has been a lot of talk about retirement lately on the heals of a devastating market drop. Most investors saving for retirement are heavily invested in stocks so the market downturn took their account value with it. Those who are near retirement are often put in a position where they can no longer retire as expected or may have to suck it up with a reduced nest egg.

So, there’s good reason that the 401(k) plan has been on the hot seat. With most employees lacking a full pension plan and the expectation that Social Security will only barely provide enough income to pay a few bills, the weight of retirement falls squarely on your own retirement savings — and for most people that comes from their 401(k) or IRA. But when these plans don’t live up to all the hype a lot of people are being left high and dry.

The Good

Let’s start with the benefits of the 401(k). The obvious benefit comes from the special tax treatment. When you think about it, a 401(k) is just a few lines of tax code anyway. With a 401(k) you have the ability to reduce your current taxable income by making contributions. In addition, you defer taxes until withdrawal so your money can grow even faster.

Some people are fortunate enough to work for an employer who matches some of their contributions. This “free” money can really help accelerate the building of your nest egg.

And let’s not forget how easy it is to take part in your employer’s 401(k). It’s all done through payroll deduction so you don’t have to worry about setting up an account somewhere, making deposits, or any of that. It couldn’t get any easier.

The Bad

While there are many benefits to these plans, they don’t come without drawbacks. One thing to note is that 401(k) plans are not mandatory. Not all employers offer them and those that do may restrict the benefit to full-time employees. This puts a lot of workers in a situation where saving for retirement in a 401(k) isn’t even an option. Some companies also do not match contributions.

In many cases these plans have very limited investment choices and may include funds with high expenses. It isn’t uncommon to be charged 2% annually on the investments in a 401(k) compared to the fraction of a percent charged if you were to go out and invest on your own.

And finally, there are a lot of restrictions that come with a 401(k) plan. You have special withdrawal requirements, have to keep it with your current employer unless terminated, and of course the penalties for premature distributions.

Does the Bad Outweigh the Good?

If you ask some people in Congress, they call the 401(k) “little more than a high-stakes crapshoot” and would like to scrap them entirely. But are these plans really as bad as they make them out to be?

There are obviously some glaring problems with our retirement programs, but you know why? They are all centered around taxes. When was the last time you thought of our tax system as streamlined? Exactly. It doesn’t matter if you’re talking about a 401(k), 403(b), 457, Traditional IRA or Roth IRA, each one of these so-called retirement plans are just fancy words for special tax treatment. No more, no less.

Because of the emphasis on taxes these plans are primarily used by those with higher incomes. The more money you make, the more taxes you pay, so the harder you’re going to work to reduce your tax bill. Your typical working-class American earning $30,000 a year can usually care less about shaving a few hundred dollars off their taxes even if they could afford to put some money aside for retirement. To try and sweeten the deal the government even began offering a tax credit for lower income employees who save for retirement in a 401(k) or IRA and most people still don’t take advantage of it.

Lack of participation and not saving enough for retirement are the problems, yet all you hear about from lawmakers is about the fees and optional nature of these plans that need to be fixed. There are clearly fee issues that need to be addressed as these are cash cows for the investment companies who offer them, but let’s think about it for a moment. If you can’t get people to save for retirement by offering tax deductions, tax credits, and in some cases even free company match money, do you really think trimming fees by a percent and making sure each plan offers a few index funds is going to suddenly put people on track for retirement? Of course not. It would certainly be beneficial for everyone who is saving in a 401(k) but it’s far from the actual problem.

Let’s fix the problems with 401(k) plans where we can, but let’s also realize that most people simply don’t save enough for retirement. Period. And you won’t be solving that problem by maintaining a voluntary system that offers nothing more than a little tax break.

Expectations

There is also a problem with expectations. For years we’ve been told to just continue to stick money in a retirement plan and come time for retirement you’ll have a pile of money. Ok, sure. If you continue to put part of each paycheck aside and don’t touch it for 25 years, chances are you’ll have some money to retire on. Unfortunately, the expectations of saving money, compound interest, and time are often just crude marketing tools used by the financial industry to encourage saving. While this can certainly lead to wealth, retirement planning goes far beyond this simple formula. But people have just latched on to the expectation that if they save 10% of their paycheck they will magically have all the money they will ever need in retirement. As we all know, it doesn’t quite work that way.

I don’t have to say much about expectations when it comes to investment returns. We all know how dangerous that can be. People will say stocks return 10% a year on average. Sure, if you dig up enough data, history does indicate that. But average return does not equal actual return. When people use compound interest calculators to predict the size of their nest egg a compound interest calculator can be very dangerous since it literally compounds the same rate of return year after year. We all know that doesn’t happen in real life and there will be years or even consecutive years with losses. While it may all average out in the end, those bad years can take a toll on any portfolio, especially if an investor makes changes during that time.

So, just expecting that if you save money you’ll be fine, or that if you invest in stocks you’ll average double digit returns, or that asset allocation can prevent you from losing money is dangerous. It’s time for investors to readjust their expectations in line with reality. Is it the 401(k)’s fault that you lost 40% of your portfolio of all stocks when the market dropped? Is it the 401(k)’s fault that you didn’t accumulate a million dollars before retirement because you were only saving 3% of your income? There are clearly some areas that need to be improved, but many of the faults have nothing to do with retirement plans at all and are just a function of investor behavior.

Buy and Hold is Not the Same as Buy and Forget

One of the arguments coming out of this recession is that buy and hold is dead. Over the past ten years stocks are flat. You could have made more money by hiding it under the mattress or leaving it in a savings account. When people see that they have not made any money in ten years by investing in stocks it’s an easy argument to make. You bought, you held, and you didn’t make a dime.

The problem isn’t that buy and hold doesn’t work, it’s that most people buy and forget. You can’t just throw some money in the market and expect everything will just turn out fine when you’re 65 and ready to start drawing on it. You have to be involved with your retirement savings and understand that your goals, needs, the market, and investment objectives are constantly evolving. You need to rebalance your portfolio, you need to begin shifting assets around as you get closer to retirement, and you probably need to change how much you contribute to your plan over time.

Buy and hold just means that you invest some money with the intention of holding it for a while instead of trying to time the market. It doesn’t mean you pick a few funds to invest in, set your contribution rate to 5% and never look at your account for ten years and just assume everything is fine. Unfortunately, that’s what many people do with their retirement accounts and then they are shocked when something doesn’t go as planned.

Consider this. Would you go to the gas station and fill up your car with gas and then hit the freeway, get up to 70 mph and set the cruise control and let go of the wheel and take a nap just hoping when you wake up you’ll be at your destination? Of course not, that’s insane! But that’s exactly what most people do with their life savings. They put a little gas in their tank with each paycheck and then hit cruise control just hoping by retirement everything will turn out fine.

Some Final Thoughts

There is clearly some room for improvement with our retirement programs. The 401(k) landscape is very complicated and it doesn’t put everyone on the same playing field. These aren’t mandatory plans so some people don’t even have access to them, others are offered with poor investment choices, and even more with high fees. So you can have two people working identical jobs making the same amount of money while working for different employers and their retirement options can be completely different.

People just aren’t saving enough for retirement. That’s the problem. We can identify all the deficiencies that retirement plans have, but it won’t solve the problem of people not saving enough, if at all for retirement. Giving people a minimal tax deduction or even a tax credit isn’t enough to encourage more savings, so what’s next? I don’t have the answer, but I know that basing the entire retirement system on a few tax benefits will never be the solution. People should be saving for their future whether they get a tax break for doing so or not, but it just doesn’t happen.

So, is the 401(k) broken? I don’t think so, but I do think it’s a bit like driving a 20 year old car with 250,000 miles. Things don’t work as well as they used to and it’s probably missing some now common new features, but it will get you from point A to point B if you use it properly and take good care of it. The 401(k) is due for a tune up, but it is still a valuable tool for those who take advantage of it and know how to use it.

I write this because I almost forgot about the June 15 deadline myself. It wasn’t until last night that I saw a little reminder on my computer alerting me to today’s due date. It has always confused me about the due dates for estimated taxes. The last payment was due on April 15th, yet the next payment is due only two months later. Then the next one isn’t due until September, and the final one isn’t due for another four months in January of next year.

Why can’t the due dates just fall every three months? I’m sure there is some really good reason for the odd schedule, but then again it is the IRS and we’re talking about the U.S. tax code here. We all know how streamlined that is!

All kidding aside, your next quarterly estimated tax payment is due today. The easiest way to make these payments is online through EFTPS.gov but you can still mail it in with a voucher if you want.

The Payment Schedule

If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return. The payment periods and due dates for estimated tax payments are:

April 15
June 15
September 15
January 15

Have you been wondering if you should even be paying estimated taxes? Don’t worry, you’re not alone. If you aren’t sure, be sure to check out IRS Publication 505 for all the information you could ever want on estimated taxes. It’s better to be safe than sorry and end up with underpayment penalties, so check it out if you’re unsure.

And don’t be like me and wait until the last day to remember. Set up scheduled payments with EFTPS or set a reminder for a few days in advance.