Many of us prepare budgets to tell our money where to go before the beginning of the month. A budget is a very useful tool that tells our money where to go and assigns every dollar a task. It’s a projection of our future financial goals, month to month. A budget include 2 parts: income and expenses. We list all the money coming into the home (income) and subtract all the expenses coming out.
Most conventional budgets require you to list your expenses based on category. So for example the housing category may include your mortgage payments, property taxes, utilities & mortgage insurance, the food category may have items like: groceries & eating out. As you go through the expense section of your budget you may have 5 or more categories (housing, food, utilities, entertainment, vacation, insurance etc.) each having multiple budget line items and amounts underneath.
This approach to preparing a budget is good if you are trying to figure out how much you spend in different areas of your life. Similar to the money pie chart (or life pie chart).
What this budget fails to show is how much of your take home pay is going towards covering your needs and how much is going towards covering your wants. What if you were to prepare a monthly budget and put your monthly expenses not based on category, but rather, based on wants and needs?
Why would you want to make up a budget using this approach? Well it’s simple, figuring out what your needs and wants are makes you ask the tough questions like: is this expense really a need, or a want disguised as a need? Can I do without this expense for a few months? Can I reduce the cost of this expense? Asking yourself these tough questions may make for an effective budget planning than placing your expenses by category. If you are really honest with yourself, preparing a budget based on wants and needs can be a real eye opener.
So what is a need? A need is anything that is required in your life to survive. The expenses in these categories may be reduced, but can seldom be eliminated. Examples of needs include: rent/mortgage payments, groceries, electricity, internet access etc. Alternatively, what is a want? A want is something that would be nice to have and may even make your life easier, but that you don’t need to survive. Examples of wants include: eating out, vacations, cigarettes and alcohol, cell phone with data plan etc.
So how does a ‘needs and wants budget’ look like? Glad you asked. Here is a hypothetical sample needs and wants budget:
|NEEDS AND WANTS BUDGET|
|Monthly Take Home Pay 1||
|Monthly Take Home Pay 2||
|Total Monthly Take Home
|Monthly Expenses: Needs|
|Phone & Internet||
|Property taxes/ other taxes||
|Savings for Kids Education||
|Minimum payments on debts||
|Total Needs Expense||
|Monthly Expenses: Wants|
|Entertainment & Eating Out||
|Cable & Other Subscriptions||
|Additional Payments towards debts||
|Total Wants Expense||
Of course everyone’s needs and wants budget will look different, and that’s ok. A budget is meant to convey the personal financial goals and prioritizes of each person and so it will look different for every person.
When is the best time to use a ‘needs and wants’ budget as opposed to a conventional budget that looks at expenses by category:
- When you are ready to be honest with yourself and do a proper inventory of what you consider a “need” and a “want” in your household?
- When you want to find out what percentage of your take home pay goes towards frivolous or discretionary spending?
- When money is tight and you need to consider only the bare minimums needed to survive? For example: dropping down to one income due to a new born baby, getting laid off?
- When you want to get a fresh perspective on how you spend your money?
Another great purpose for the needs and wants budget is that it allows you to quickly eliminate expenses without having to change the entire budget during hard financial times by:
- Eliminating expenses you can do without in the event of a job loss. For example, in most instances, you should be able to reduce your total ‘wants expenses’ down to zero in the event where there is reduced income.
- If you are still in the negative once your ‘wants expenses’ are eliminated, you can find creative ways to reduce your ‘needs expenses’, including:
- Grocery shopping with a list
- Using public transit
- Watching the consumption of energy in the home etc.
- Encouraging you to be more frugal by finding ways to reduce your wants and needs expenses.
The caveat in preparing a “needs and wants budget” is that the final outcome of the budget and what it reveals will only be as honest and telling as the person that prepared it. Determining what are ‘needs’ and ‘wants’ are in the society that we live in today, where every convenience is at our disposal and everything feels like a need can be challenging.
Although I also use a category-based budget for my financial planning, doing an exercise like this can be very beneficial.
If you are ready to ask the hard questions, this budget can reveal a lot.
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