The Balanced Money Formula
Published on - October 27th, 2008 (Modified on - November 10th, 2009) (by J.D. Roth) Building a budget is one of the basic tasks of personal finance. But not everyone can keep a budget. As much as I’d like to, I don’t feel comfortable with detailed planning. I continue to use a spending plan as a rough guide to my future, but a traditional budget just doesn’t work for me.
Last night I stumbled across the Balanced Money Formula proposed by Elizabeth Warren and Amelia Tyagi in their excellent book, All Your Worth: The Ultimate Lifetime Money Plan [my review]. Like my spending plan, the Balanced Money Formula is an alternative to traditional budgets. Though I considered this concept a little “light” in the past, it really hit home yesterday. It helped me to realize that my own spending has become unbalanced.
The balanced money formula
The Balanced Money Formula is based on your net income (your income after taxes). Warren and Tyagi say that, ideally, no more than 50% of your paycheck should be spent on Needs (and keeping them below 35% is best). Of the remaining amount, at least 20% should be devoted to Saving, while up to 30% can be spent on Wants.
Here’s what it looks like:
That’s it. Simple. Three categories. No detail. This is the sort of Big Picture budget that I find useful, and in this case I could see that there was something wrong with my Wants. Here’s how the authors define these terms:
- Needs are things you must pay no matter what: housing, food, utilities, transportation costs, insurance.
- Wants are everything else: cable television, restaurant meals, concert tickets, comic books, clothing beyond the basics, etc.
- As in the list of tips I shared a few days ago, Saving comes last in this plan. Everything left after you take care of Wants and Needs is set aside for the future. (If you want to get out of debt, that’s also tackled here.)
Warren and Tyagi write:
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’s 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 Hummel figurines, 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.
The authors say that 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?
Warren and Tyagi write, “You can spend your Wants money on anything that strikes your fancy, so long as you stay within 30% of your income.” In fact, they 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: I’m spending less than 10% of my income on fun, and I can tell. I’m growing a little cantankerous in my old age. I’m letting things like a trip to the movies raise my blood pressure, when I should just be enjoying life. I’ve paid off my debt. I’m not spending foolishly. I can afford to go to a movie, even if it is expensive. I can afford to spend the extra 29 cents to have a great mug of cocoa.
All work and no play
I’ve written a lot lately about frugality, and I’m not about to give up my frugal ways. Thrift has been successful for me, has helped me to build wealth. But as some readers 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 last night brought this point home to me.
I’ve allowed my own money equation to become unbalanced again. Over the past few years, I’ve become a Super Saver. Initially, this money went to debt reduction; now it goes to saving and investing. I’m proud of paying off my past and providing for my future, but maybe it’s time to spend a little money on today. Maybe it’s time to indulge myself. Maybe it’s time to give myself a budget for fun.
To learn more about the Balanced Money Formula, borrow the excellent All Your Worth from your public library, or check out this interview with the authors. Photo by SuperFanastic.
This article is about Basics, Books, Budgeting, Money Hacks
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50%-needs
15%-wants
35%-savings.
We are in our mid 20s right now. We are aggressively paying down some debt which accounts for about 75% of the savings total. It is possible to save more. We don’t feel stressed out about not having everything we “want”. Truth is, we don’t need a lot of stuff right now anyway. It makes our lives easier!
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Overall I’m in agreement with a simplified approach, the problem lies in how and with whom (as in spouse)you determine the differences between Needs and Wants. Additionally, where do investments and retirement fall in?
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JD,
The best ever cocoa mix is DAGOBA. You can find it in health food stores like Whole Foods Market or New Seasons.
________________________________________________
Now about the post:
What a great way to test your balance.
Unfortunately, we are at:
65% Needs (Mortgage is high because location (good neighborhood in Portland) is a priority for us)
28% Savings and Debt Payments
7% Wants
On the other hand, as an Engineer, I LOVE numbers, the more detailed the better
so I find this too simple.
I like the 60% solution more. http://articles.moneycentral.msn.com/SavingandDebt/LearnToBudget/ASimplerWayToSaveThe60Solution.aspx
60% to Committed Expenses such as taxes, clothing, basic living expenses, insurance, charity (including tithe), and regular bills (including things like cable).
10% to Retirement.
10% to Irregular Expenses such as vacations, major repair bills, new appliances, etc.
10% to Long-Term Savings/Debt — money set aside for car purchases, home renovations, or to pay down substantial debt loads.
10% for Fun Money to be used for dining out, hobbies, indulgences, etc.
Copied from JD’s post:
http://www.getrichslowly.org/blog/2008/09/12/the-budget-toolbox-13-tools-for-building-a-better-budget/
With this method (after taxes), we are more like:
65% Needs
8% Retirement/Real Estate Investment
3.5% Irregular Expenses
16.5% Debt Payments
7% Fun
As JD always says, do what works for you.
-Charlotte
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It’s a tough ratio to abide by, but I like the idea of setting up a conservative, savings-aggressive budget. Once you set that up and it works, the idea of not thinking about it and just living your life is great. Instead of feeling really guilty about every little purchase (which happens very often), this let’s you just group it in it’s right place and you’re done. No guilt.
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70% Needs (50% tuition and 20% living expenses)
2% Wants
28% Savings (this is really just short term savings for future tuition debt payments, the balance all comes out to 0 by the time I graduate).
Law school tuition is ridiculously expensive ($35k/year), but I should be able to graduate debt free. I can’t wait to actually have the time to actually spend on wants, it isn’t really a choice that I only spend 2% on it, it is just simply I have no time to do things like play console games or go out regularly with 30 hours of school, 30 hours of work and a 1.5 hour commute.
I can’t wait until I can get on a more balanced budget, I am thinking something like:
30% Needs
20% Wants
50% Savings
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I often return to this book when I feel like I’m on the brink of being overextended, financially. Is my house too expensive based on my income, or conversely, how much of a raise do I need to feel better about living in a house with this size mortgage? The plan makes you face your must-have expenses, and address your savings, then anything left over can be spent on wants. It’s a great book that deserves some attention, especially as people will need to take stock of their personal situations in this time of uncertainty (like direct your 20% savings to build a 6 month emergency fund).
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This is a fun “budget-lite” framework to consider.
If the 403b may be considered “savings,” then my breakdown is:
Needs 36%
Wants 27%
Savings 37%
If the 403b is not included, the numbers really shift:
Needs 50%
Wants 37%
Savings 13%
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Interesting. So I basically need a six figure income to fulfill the needs of a basic middle class existence while living in a low-cost part of the MidWest.
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I might have to re-evaluate my conclusions. Perhaps some of my Needs would be reclassified as “wants” – though everything I consider a need now is pretty much essential and non-negotiable.
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I am in a similar position to you JD, though I suspect I have a lot less income! I tend to save any left over money at the expense of wants.
However it’s worth noting that with saving and investing producing it’s own income in time, you can have a share of that as want spending as well, and increase net want spending while saving even more.
At the start it’s the most important to put the effort in and save as much as you can. Then the savings snowball can roll down the hill gaining momentum and size.
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JD – One trick on cheaper movie passes is you can get them at warehouse stores like Costco! A pair of Regal movie tickets cost me $14.99, and are sometimes accepted for the new movies! With the cheaper tickets, you can even buy a large soda or candy for the price of two regular tickets
Have fun!!!
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When are you “allowed” to spend your savings? I have slowly been building an emergency fund, but today I had to spend $350 to fix my car. I’ll be paying for it from my emergency fund savings. Was this a legitimate use of my “savings” for this model?
Also, how should I categorize that $350? Do I ignore it for the purposes of this model, because that money was essentially already counted as my savings contribution a few months ago?
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“are you making enough room for fun?”
For me, fun and happiness is not a function of how much I spend. My happiness is more related to how I spend my time and how content I can be with the things I already have.
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Hmmm, this is good for most, but how would yearly expenses be saved. In the UK, the govt gouges a tax so we can drive on the roads, it’s about £200 a year, I’d class that as a Need. Should I divide that by 12 for the monthly amount? Should I do the same for all yearly expenses? What about the holiday I have a year, a large payment just once in the year? As Richie (62) says, how would you categorize emergency fund saving – a need? Ta for the post, very thought-provoking…
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The balance definitely seems to be variable. People who earn very little are obviously going to have higher needs (35% on housing alone can be tough). We probably spend about 5% on wants, and that feels like luxery to us since our income effectively tripled over the past year (including benefits) – so that 5% has tripled also.
We’re probably at first glance something like, 70% needs – but it’s mostly house, which is also savings and a want, with the remianing split 25% savings, and 5% wants. Post-tax. But we don’t WANT to spend more on wants.
Once we pay off our house, we’ll only be spending about 25% on needs. Our savings goals after that point can be met with 6% of our current income (6% of our current income goes into retirement). Our wants can be met with 5% of our current income. Total = 36% of our current income. So we’ll probably cut our income to half of the current amount I make by having me cut back to part-time, making our current budget(sans hosue) 50% needs, 12% savings, 10% wants. We will then have 28% of our new income to split between additional savings and wants. This is why our housing needs are also wants. We are considering downsizing our home to make this dream happen faster (we would need to move yet further from work, but if I only work two days a week we can do this). This is why our house is also savings.
So, it is balanced from a long-term point of view. Needs, wants, and savings are not always clear-cut seperate categories, though.
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@ Dotty #14
You might want to consider “investing” in a TFSA (tax free savings account). After looking into it a bit I’ve decided to plunk down my baby emergency fund into a TFSA. Because interest above 50$ is taxed, this is a way to avoid current and future taxes (here’s the kicker) WITHOUT affecting future government options (EI, Welfare (??), Social security) From what I understand you can invest in mutual funds and still call it a TFSA. The banks are calling it the RRSP for the “rest of your life” goals. You get 5000$ a year to contribute and I don’t remember if it rolls forward. Also note it’s not tax deductable (you don’t get your taxes back) it’s tax free (you don’t pay taxes on it)
A quick google search will explain more than this nutshell approach. It’s not coming out until Jan 2009, but ING has a special prelaunch offer, you should check it out:
http://www.hugthetaxman.ca/
Hope this helps
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And what if you want to ensure a secure and comfortable retirement knowing social security won’t be around… is it then ok to send 40% of your income to savings??
How does the want of free time later in fit in with the wants of today…
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I don’t think I could do this formula. Rent and my gas alone is 50%. That leaves no room for student loan, cell phone, internet/cable, credit card.
It sucks living in California.
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This is reasonably similar to the approach outlined in the book “My Own Two Feet” where the authors propose that about 60% of your income go to Foundation expenses (Needs), 20% to Future expenses (Savings), and 20% to Fun (Wants). I think that upping the Foundation expenses to 60% makes more sense for urban areas, like Los Angeles where I live. In fact, even 60% might not be enough. For many here 60% wouldn’t even be enough to cover their rent, let alone other foundation expenses.
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I loved this article and some of the coments. I have always made myself a budget but sometimes forget the fun stuff and didn’t budget for it and so went over my budget. I will now add that in, everyone needs some fun time or its not worth working and saving. If you don’t have time or money to do things you enjoy, you don’t enjoy life.
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JD, FINALLY! HOORRRAAAYYY!! It’s about time you gave us a blog which is actually a USEFUL tool! Sorry, but I’m not a big fan of miserly tips like “how to save 29 cents…”, I would much rather target big ticket items first… requires less effort!
So kudos to this great find. I have been using a detailed budget for over 10 years and have come to the same conclusion, KEEP IT SIMPLE!! Here’s my breakdown. I see I need to save more!
18% save (7% 401k, 11% short+long term)
51% need (21% mortgage, ins, taxes, 12% auto)
19% want (9% vacation, 10% gifts, cash, dining)
12% other (trying to move this to savings)
My future target savings for 2009 is 25-30% net, or about 3 months equivalent monthly expenses. This will create a 6-month emergency fund in 2 years time.
Conrad
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I’ve been working towards a variation of T Harv Eker’s that goes like this:
50% Needs
10% Financial Freedom
10% Long-term Savings (cars, weddings, Xmas)
10% Tithing
5% Education
15% Fun money
Looking at it through the Money Plan, that sounds like FF, tithing, and education could be taken as ‘investment in the future’/savings, and LTS, and fun are Wants. I guess this is really up to the individual – what is a need and a want.
He also recommends using jars at home – put $$$ in, or the checkbook. Make it visual, and it’s easier to keep in mind.
Of course, I don’t think there are any hard and fast rules. It’s a process we’re working on, and habits we’re developing.
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IMO this is a solid, time tested approach. Here’s a link to a balanced money summary that provides more details and guidelines. There’s also a free excel spreadsheet with decent instructions and summary graphs. http://www.mdmproofing.com/iym/BMF.shtml
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I am 28 years old and currently working for a company. I make 595 dollars (another country; average rent is 357 dollars) a month. I have opened up a retirement month account and save as much as possible. Now my savings goes toward our wedding but once we finish with it I would like to save for a Europe trip. I am thinking about this balanced money formula lately and how it can be incorporated to “small” incomes. Can you help?
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I think the point of this formula is that it represents how money can be used to fulfill its role in our lives – to provide us with our basic needs, to plan for our future and to enjoy ourselves. I think the ratio is recommended for creating a happy balance. Maybe you can’t meet that now, maybe you had a big ‘want’ years ago for a really nice house and now you have a ‘need’ now to pay the mortgage on it. But basically, it helps me remember than money does buy fun and its not a sin to spend on things we like. I’ve had periods of time when rent alone was 70% of my income and no, it was not a happy time for me. Right now I do live on half my income and yes, I feel wealthy. Even crises don’t phases me too much. It is a peaceful reassurance to know that you can manage a crisis by cutting back savings and needs for a year and be done with it than to spin into panic because you’re already stretched to capacity. It also should reassure people who are stretched that they won’t always be able to save and save and spend 0% of their needs – it’s like a starvation diet that will be inevitably broken. Balance gives us choices, and that’s always good.
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I think it can get a bit tricky to figure out where the line is between Needs and Wants. When I ran the numbers for our household, I put housing expenses, groceries, transportation, clothing, health care, personal care, and office supplies under Needs, while restaurant meals, entertainment, cat care, charitable giving, and gifts fell under Wants. However, I know that some of the things I’ve lumped in under Needs are really Wants. For example, the gas we use for commuting is a need, but not the gas we use for driving to a concert or to visit friends. We need to own some clothes, but not every piece of new clothing we buy is something we absolutely needed. Much of the money we spent on home maintenance is necessary (to keep the roof over our heads), but some of it is optional (like refinishing the basement). So I think my estimate of 43 percent for Needs is a little high, while my 12 percent for Wants is low. According to Warren’s formula, we’re spending far too little on Wants, but we don’t feel deprived. So I think it’s useful to remember that the lines between these categories are a bit fuzzy.
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One question: how can you use your savings?
If, for example, I decide to buy a car at the end of the year using my savings, in which category does this expense go? Should it be in wants, because I don´t necessarily need it asI allready have one? Or could it be considered a saving itself, as i´m investing in a new car. Or, even more, it could be considered a nees, as i will sell the old car and I need to have a car. Any advice?
Also, just to be sure, the holidays are considered wants, right?
Tx!
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Yea I think you hit home with this one for me too. I hate a budget and when I’ve set one before I can never discipline myself to keep it up.
Thanks for finding this balance formula I think I’ll have to start doing that.
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Okay, I’m a bit of cynic. Currently as guesstimate we spend about 20% on needs, 15% on wants and 65% in savings.
Do we need to save that aggressively? I would say no, but I guess I don’t see how spending more on housing or vehicles would improve my life. My crew enjoys cheap recreation mostly (DH is a golfer
the exception) We travel and do lots of fun stuff. I get great peace of mind in knowing I can afford to eat out or get a latte anytime I feel like it. That’s different than I choose to do it that often. It’s more fun and more of a treat when I act like it’s a treat, not a birthright.
I also don’t think that saving 20% is going to give my family (or most other families) enough savings to retire, replace cars, and be real finicial help to college aged children. I am personally on the fence that a 100% parent-paid college expereience is in young persons best interest. I know a ton of student loans aren’t either.
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I have a question: When you, or Elizabeth Warren, say – save 20% of the money out of your paycheck, are you then excluding the 401(k) contribution which has already been subtracted from your pay and not reflecting in your actual net pay?
Just wanted a clarification.
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