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Consumer Finance: Balancing Your Money Equation

By Ifeoma Tete Mbuk
Frugality can help you build wealth and be successful. But as some school of thought have noted, one reason to save money is to enjoy it. It’s not just for the future, but for today. Re-visiting the Balanced Money Formula by Warren and Tyagi brought this point home.

The Balanced Money Formula is based on your net income (your income after taxes). It says that, ideally, no more than 50% of your income should be spent on Needs (and keeping them below 35% is best). Of the remaining amount, at least 20% should be devoted to Savings, while up to 30% can be spent on Wants.

· Needs are things you must pay for no matter what: housing, food, utilities, transportation costs, insurance.
· Wants are everything else: cable television, restaurant meals, concert tickets,  clothing beyond the basics, etc.
· Saving comes last in this plan. Everything left after you have taken care of Wants and Needs is set aside for the future. (If you have consumer debt, that’s also tackled here.)

When your money is in balance, you always have enough to pay your bills, have some fun, and save for your dreams. And here is the best part of all. Once your money is in balance, you can stop worrying about it. Managing your money becomes automatic.This Balanced Money Formula is a goal. It’s an ideal. If you’re just beginning to manage your money, your financial life will probably be distinctly unbalanced.

For example, if your income is small (or your mortgage is large), you might be spending 80% (or more) on Needs. If you are a compulsive spender, if you like to dine in fine restaurants or to collect vintage art works, you might be spending 45% of your income on Wants. And, of course, few people starting out can afford to set aside 20% of their income for Savings.

Your goal should be to move from your current state to something more balanced. For some, that’s as simple as re-prioritizing expenses. For most, it’s not that simple.

When your Needs are too high, for example, you severely cramp both Wants and Savings. Because most of your income goes to necessities, you don’t have enough for fun or for the future. To remedy this, you might need to take drastic action. You might need to move into someplace more affordable (perhaps even to a different city). You might need to find a better-paying job. These are not easy steps.

Life out of balance
In many ways, the Balanced Money Formula is brilliant. I agree wholeheartedly that Needs should be kept under 50% of net income. (I think it’s a good idea to split Needs: about 25% for housing, about 25% for all other Needs.) I also agree that saving at least 20% of your income (or using that money to repay debt) is an excellent way to find the path to wealth.

But what about that 30% for Wants?
“You can spend your Wants money on anything that strikes your fancy, so long as you stay within 30% of your income.” In fact, the authors warn against spending too little on Wants, suggesting that those who spend less than 20% of their income on the things they enjoy might be missing the point of money. “You certainly won’t get into trouble spending like this on Wants,” they say. “Even so, you should ask yourself — are you making enough room for fun?”

Excellent question and here’s the truth: Am I am spending less than 10% of my income on fun? Am I growing a little cantankerous in my old age? Am I letting things like a trip to the movies raise my blood pressure, when I should just be enjoying life? I have paid off my debt and I am not spending foolishly. I can afford to go to a movie, even if it is expensive. I can afford to spend the extra to have some good brandy.

All work and no play.
You can allow your own money equation to become unbalanced again, if over the past few years, you have become a Super Saver. Initially, this money went to debt reduction; now it goes to saving and investing. You are proud of paying off your past and providing for your future, but maybe it’s time to spend a little money on today. Maybe it’s time to indulge yourself. Maybe it’s time to give yourself a budget for fun.


Comments expressed here do not reflect the opinions of vanguard newspapers or any employee thereof.