Hi everyone! Welcome back to Melissa Making Cents!
There is something very special about witnessing a financial coaching client growing into being a confident money master. It's not always an easy process to change habits that have taken a lifetime to learn. It is, however, a journey that is worthy of the changes because there is a big difference in controlling your money; rather than letting your money control you.
I’ve recently been talking a lot about the power of budgeting. In some of my previous Melissa Making Cents blog posts, I’ve shared my enthusiasm for the 50/30/20 approach, in which 50% of your after-tax income goes toward “needs,” 30% goes toward “wants,” and the final 20% goes toward “savings.” However, in working with many of my financial coaching clients, I’ve found that categorizing all spending by these three buckets isn’t always easy. What do you do if you’re not sure if an expense qualifies as a “need” or a “want”?
Even if they sound self-explanatory, wants and needs have become a gray area these days. For example, is a new fall jacket considered a “need” because it’s an article of clothing? Or is a new car a “want” if your current one is old, but still working? So today, I’m going to break down which types of expenses usually fit into the “needs” category and which usually fit into the “wants” category, as well as how that impacts your financial planning.
Needs are items and services that are essential for survival.
You’ve probably heard before that “needs” are those things you cannot live without. And no, I’m not talking about your smartphone! In general, your “needs” tend to be fixed expenses that you must pay every month and the absence of which would cause harm to your well-being. These include:
- Shelter
- Food
- Transportation
- Healthcare
- Insurance
- Clothing
Not surprisingly, your rent or mortgage payment would fall into the “needs” category. So are the groceries you buy, and any insurance premiums you have. If you commute to work, other needs could include your public transit card, car payments, and car insurance and maintenance. Any healthcare expenses you have (such as insurance premiums, copays for doctor visits, prescriptions, and vision or hearing aids) are also needs. And while you probably shouldn’t order new clothes every day, you do need to make sure you have things to wear that are appropriate for the weather and for your career (scrubs for a nurse, a suit for a lawyer, etc.).
Depending on your situation, you may have other needs that don’t fit neatly into one of the above categories. For example, if you and your spouse both work, then childcare might also be a need. If you are working from home, a computer and Internet access are both needs too because you wouldn’t be able to earn income without it.
Listing out your needs within your budget is important for everyone, but especially those who have irregular income and may need to prioritize their expenses a bit more. I also highly recommend building up an emergency fund so that you can still cover your needs in the event of a major loss of income.
Wants are items and services that are nice to have, but that you can live without.
If “needs” are the things that enable you to live, “wants” are the things that make life more enjoyable. Usually (but not always), your “wants” are variable expenses, which means you can change the amount you spend on them every month. Wants might include:
- Travel
- Entertainment
- Restaurants
- Subscriptions
- Fitness classes
In most cases, if you can cut it out of your monthly expenses and still carry on with your life, it’s a “want.” If you forgo those fitness classes or that gym membership, you can still work out at home. If you don’t go to the movies with your family, you can play a board game at home. And if you don’t take a road trip during the summer...well, there’s nothing wrong with a staycation!
This isn’t to say that you should feel guilty about spending on “wants.” After all, wants can be a fun way to reward yourself for all your hard work. It’s just about maintaining a healthy balance. The main thing to remember is to make sure that you don’t spend beyond your means, which is why a model like the 50/30/20 rule is helpful for so many of my clients.
Sometimes, needs and wants can overlap and there isn’t a clear distinction between the two.
What happens to items that fall somewhere in between needs and wants? Can some items be both a need and a want? The short answer is--yes, they can!
Let’s go through a few examples.
Even though food is a need, buying snacks and desserts, higher-end products like organic produce, or expensive ingredients to make a fancy dinner at home would fall into the “wants” category instead. Regular milk, bread, and eggs are more likely to be classified as “needs.”
Similarly, your utility bills may also include both needs and wants. While a basic phone is probably a need, a smartphone with an unlimited data plan is closer to the “wants” category. Air conditioning is likely a need in an extremely hot climate, but a full-service cable package is more solidly a want. (And for the record, Netflix is a “want,” too!)
Even something like housing--which is a need, because it provides shelter--can cross over into the “want” category. For example, if you choose to spend more for a house with a pool or an apartment close to a nice park, then the extra money for access to those amenities would be considered a “want.” One way to break this down in your budget is to take the total amount you’re spending on housing and dividing it into both “needs” and “wants.” So if you’re spending $1,000 per month on rent for an apartment near the park but would have been able to rent an apartment for $800 that’s away from the park, include $800 toward the “need” category in your budget and the $200 premium as part of the “want” category. It doesn’t have to be a strict calculation, but there should be some representation in both buckets.
On the other hand, some items that might usually be considered “wants” could actually be “needs,” too. For example, if you work in a career where physical appearance or clothes are important for making a professional impression (such as a model, a lawyer, or another client-facing occupation), you might be justified in spending more money for designer brands or cosmetics. Similarly, home internet would usually be considered a want (even though my daughter disagrees!). However, if you work from home or your child needs internet access to do their homework and can’t go to a library, then it becomes a need.
Wants and needs can be somewhat fluid, especially during COVID-19. So it helps to reevaluate your budget frequently. Speaking of which...
Adjust your expenses accordingly, if your spending in one category seems too high.
If you’ve found that your expenses are too high compared to the income you’re bringing in, there are several things you can do. First, you may wish to reduce the amount you spend on your wants. If you’re used to going out to eat three times a week, try going only once or twice a week instead and allocating the rest of that money either for savings or needs. If you like to take vacations, try going during the off-season when there are more likely to be deals, or opt for less expensive hotels or destinations. You could also make a list before you go to the store in order to avoid impulse buys on junk food.
Contrary to popular belief, it is often possible to cut back on the money spent on your needs too. For example, you may be able to switch to a cheaper phone plan, shop around for car insurance, or find less expensive childcare options. Another fun tip is to avoid grocery shopping when you’re hungry, since hunger makes you more likely to overspend!
Adjusting your expenses just takes a little creativity. That’s why it helps so much to track everything, so you can see where you would be able to make the changes you need.
Still not sure how to prioritize everything? Try breaking it down into four categories instead of two.
Even after you’ve broken everything down into “needs” and “wants,” you might find that not all expenses within these categories are created equal. When thinking about your “needs,” your rent payment is probably more of a priority than a new item of clothing. Similarly, when thinking about your “wants,” you might value your gym membership more than a weekly night out at a restaurant.
Another helpful way to think about needs and wants is to create a chart that visualizes how important each one is. Irecommend listing your needs in the left-hand column and your wants in the right-hand column, in descending order of priority. So in the “needs” category, you might start with rent/mortgage, then health insurance, etc. After listing out all of these expenses, draw a perpendicular line in the middle so that you have a chart with four boxes. Clockwise, those boxes will represent the following:
- High-priority needs
- High-priority wants
- Low-priority wants
- Low-priority needs
A chart like this can help you visualize where to allocate your expenses, or cut back if necessary. For example, you probably won’t touch anything in your high-priority needs category, but may choose to reduce spending for low-priority wants. This is an especially helpful technique if your income varies every month, if you are new to budgeting, or you have aggressive savings or debt repayment goals. Keep in mind that if your income takes a big hit--such as a job loss or an unexpected debt like a medical bill--you’ll probably want to reevaluate your budget, too.
Don’t forget about the savings component of your financial plan!
Let’s look again at that 50/30/20 budget rule. Since the 50% and 30% are accounted for with your needs and wants, that last 20% should be allocated toward savings. It can be tempting to forget about savings, or treat it as “leftover” income. However, saving is an important part of financial health in both the short term and the long term. Some examples of savings include:
- Retirement contributions
- College savings
- Debt repayment
- Emergency fund
- Other investments
Remember to make savings a priority, especially if you need to pay off student loans or credit card debt! You may even wish to save more than 20% if you have a big goal in mind, like amassing a down payment for a house or retiring early. Some of my favorite tricks for boosting your savings rate include implementing “no spend” days, tracking all your income and expenses, and using coupons and discounts for items you were planning to buy anyway. I’ll share more of my favorite ways to increase savings in a future post.
A financial coach can help you understand needs and wants, as they relate to your individual situation.
As you can see, needs and wants aren’t always so clearly defined. And even the 50/30/20 budgeting rule can be more flexible depending on individual circ*mstances. The most important thing is understanding how needs and wants work for you. My financial coaching program Making Cents of Your Money can help you learn how to determine the breakdown of wants and needs in your own financial plan. For assistance in creating a budget that works for you and your family, please call or email to schedule an appointment with me.
Until next time...this is Melissa Making Cents!
Melissa Anne Cox CERTIFIED FINANCIAL PLANNER™ is also a College Planning and Student Loan Advisor, and Financial Coach in Dallas, Texas.
