Do you ever get ready to make a purchase and ask yourself: “Do I really need this?” Do you keep track of your expenses and categorize them into either needs or wants? If not, it is time to start! Differentiating between the two will help you reduce your spending and increase your savings, making you one step closer to FI. Understanding the difference between needs and wants is one of the most basic concepts of managing your money. So let’s look at it.
What is a need? A need is something you have to have; it is required as a mean of subsistence.
How about a want? A want on the other hand, is something you would like to have. It is a nice to have but it is not needed.
What are typical needs in today’ society?
- Shelter (a roof over your head, heat, electricity and running water)
- Food and drinking water
- Medical and basic hygiene products
You can further breakdown needs as follows;
- Shelter. All you need is a roof over your head with heat, electricity and running water Anything beyond that is wants. Do you live in a single home small or big? Do you have cable? Nice furniture? Want, Want. Want!
- Food & Water. You need to eat a balanced diet to stay healthy. But lots of the food we buy doesn’t actually contribute to that healthy balance. Check your fridge or your pantry, how much of your food is just wants? Chocolate, crackers, cookies, ice cream are all wants, on top of being poor nutritional choices (but we all buy them so don’t feel too guilty).
- Clothing – You need to be able to dress comfortably and appropriately for whatever you have to do (go to work; wait for your bus in -30oC weather). Beyond the minimum wardrobe, the rest again is just wants. That is correct; you do not need that extra pair of shoes!
- Transportation- Depending on where you live and where you have to go, you may need a bike, a bus pass or a car. The car doesn’t have to be new and it definitely doesn’t need to be a BMW or an Audi!
Everything else is ALL wants.
Are you in your house right now? Take a few minutes and look around you. How many needs vs. want do you see? Sad truth, most of what you own is probably all wants. Discretionary spending at its worst! Needs are so very few.
Whenever you get ready to make a purchase, you should always ask yourself, “is it a need or a want?”. “Do I really need this?” You will notice over time your purchasing pattern will change, you may even start feeling guilt as you get ready to spend more money on something you know you don’t need. Even the most amazing sale doesn’t justify buying more of something you didn’t need in the first place! That money could go towards your savings and early FI instead! If you break down all your expenses between needs and wants, you will quickly realize not only could you save a lot more but you also won’t need as much as you thought you would in retirement.
Now, nobody expects you to stop spending money on all your wants, I mean life is supposed to be fun too! What you have to do is evaluate your purchases and prioritize. Once you distinguish between your needs and your wants, you will start being more selective on where you spend your money. I also found that I enjoy spending on wants a lot more now that I don’t “treat” myself as often. I used to buy expensive latte almost every day (I know shame on me!); it was part of my routine. Now that I only buy one once every two or three weeks, I enjoy drinking that latte a lot more, it even taste better!
It is all about choices. Some wants will be more important to you than others, and it won’t be the same for all of us. You may feel so strongly about certain wants that you may label them as needs for budgeting purposes. For example, I moved the internet service into our needs column; honestly I don’t think we could function well without internet at home. But if I was unable to cover our basic needs, we could just cancel the service and still be fine (Well maybe not if you were to ask my kids!). Plus we could easily go to the library or other public place with Wi-Fi if needed.
Here is how understanding the difference between your needs vs. wants will help you. Based on your own (reasonable) definition of needs and wants, and assuming you are serious about pursuing financial independence, this is how you should split your money when you get your paycheck:
- Needs. You must always pay for your needs first such as rent, utilities, groceries, insurance, bus pass or car payment. You can shop around and be frugal to try to reduce that amount but you will always have basic needs to pay for.
- Savings. Once your needs are paid for then the next step is to “pay yourself”. What you pay yourself will depend on your financial situation and what your goals are. One of my goals is to retire within the next five years so I am aiming to save 65% of my take home pay. By doing so I am increasing my savings but also learning to live on a lot less than what I earn. With three kids still living at home I haven’t reached that goal yet but getting closer every year.
- Wants. Money left after paying for needs and paying yourself. This is your fun money; you can spend it on whatever your little heart desires. You may decide to buy lunch every day for as long as you still have wants money or you may save it until you have enough for a new pair of shoes, a nice trip or a new car. If you are an overachiever, you may just keep that wants money so you can add it to your savings and reach your FI goal faster.
There is no other bucket! Your credit card is not another bucket! Whatever you purchase with your credit card is either a need or a want. If you have high interest debts, you should focus on paying for your needs and paying off your debts. You shouldn’t save or indulge yourself with wants if you have debts. Pay them off first.
To help me manage my money better, I set up two additional bank accounts (free e-Savings accounts) so I could have an account for each bucket. I have automatic transfers set up on paydays to move money out of my main account (where my pay gets deposited) to my needs and savings’ accounts. Whatever is left in my main account becomes my “fun money”. Once there is nothing left in it, I know I can’t spend on wants anymore! It makes managing my money much easier. I don’t have to think about it.
So, how about you, do you differentiate between needs vs wants? Does it help you manage your money better? What else do you include in YOUR needs?