Would you like to know the one rule that will allow you to be financially secure for the rest of your life?
The answer is simple. Are you ready for it?
I mean, financial stability for the rest of your life is a pretty big promise. This is life-changing. This will be the beginning of a new financially secure you, so prepare yourself!
Well ready or not, here it is. If you want to be financially stable for the rest of your life, do this one thing:
Spend less money than you earn.
I didn’t say it was easy; I said it was simple. If you earn more money than you spend in your life, you will truly be able to afford everything you need. If you don’t, there is very little other you can do otherwise to compensate.
Now I understand cash flow, and financial products, consumer credit, and investing can make this more complicated, but the basic premise remains the same. Another simple truth demonstrates the other side of this truth: there is no way you can earn money faster than you can spend it!
The richest people in the world can easily consume all of their assets if they were sufficiently motivated to do so, but that is not how they got rich. Nobody ever got rich by spending money. Wealth is, in fact, the degree to which you have spent less money than you have earned.
Built into this assumption is that we can live at many different income levels if we base our spending on our income rather than on our aspirations. This means we can participate in various passions, opportunities, or ventures, as long as our lifestyle is measured by the income of our circumstances, not the income of our dreams.
So the secret to financial stability has little to do with making money, or renting versus buying, or debt to equity ratios, or diversification strategies but has lots to do with our ability to tell ourselves “No.”
Self-control or self-denial is the character we will need to develop to abide by this rule. We need to understand that financial security is more important to us than a lavish but financially insecure lifestyle. Instead, we enjoy security while others enjoy material goods with the stress of strained resources.
And that is it. Obeying this one rule will deliver financial security while violating this rule will destroy any amount of otherwise fastidious bookkeeping we do. So, let’s talk about a common problem that I see in budgeting.
Needs vs. Wants
Frequently I see an approach like this to budgeting:
You have two types of purchases: needs and wants. Needs are things that support life, and wants are luxuries that are nice but aren’t actually required.
So then, let’s take a piece of paper and draw a line down the middle of it, and classify each expense in one of these two categories, then make sure we have enough money for the needs side and remove unneeded expenses until your budget balances.
This method isn’t wrong. The problem is that it generally isn’t useful. Needs and wants are largely subjective without a proper definition making this categorization mostly pointless. The vast majority of expenses fall somewhere in the middle, and when forced to categorize based on these methods, the categorization becomes arbitrary.
For instance: Mortgage or rent. Is that a need or want? Obviously it is a need because we can’t live without shelter.
McDonalds? Is that a need? I can’t live without food, but could live without fast food. Car? Probably a “want,” because I can take the bus, right?
What we end up putting under needs are things we want to be needs, and under wants the things that we are ok going without. In the above examples, there is no consideration of how much rent or mortgage we are paying. We need shelter, but we may not need a 10-bedroom, 15-bathroom, 20-acre estate. A studio apartment is also shelter. McDonalds is food, but not good food. How is it a need? A car is even more complicated. Yes, we can take the bus, but that may double travel time, which may, in turn, decrease our ability to earn money. So getting rid of your car may have a substantial adverse effect on your income. The ROI on a vehicle is going to be higher than the ROI on McDonalds, but when forced to categorize this way, we aren’t in a mindset to set reasonable, actionable goals.
This budgeting method is like dieting by classifying foods as “healthy” or “unhealthy.” Unless the terms are defined better, we will justify what we like as “healthy” and those foods we can go without as “unhealthy.” This method, in theory, is fine, but in practice it doesn’t give us a useful way of actually improving our eating habits.
The other problem with this method is that it doesn’t account for people as irrational beings making mostly emotional decisions.
People don’t make purchase decisions based on a rational assessment of needs or wants. In the moment, we make purchase decisions based mainly on the availability of money at the moment, and what we feel like buying.
The needs and wants paradigm just collapses under the weight of how human beings make decisions when money is involved.
So, I propose a different way of thinking about budgeting. It is partly defining terms more clearly so that we can’t lie to ourselves about the nature of purchases, and it is partly an acknowledgment of our own subjectivity: we want the things we want because we like them.
This method concretely defines needs, and then adds a new category called means to the needs/wants method so we can become aware of quantitative and qualitative substitutability.
Needs fall into one of the following categories:
The main categories are pretty simple: if deprived of any of these things, our lives will prematurely end. Warmth, however, is more nuanced than the others since there are three interchangeable sources of warmth. For instance, it is possible to consume less shelter by increasing clothing or fuel, or vice versa.
By defining needs in these areas, we can’t lie to ourselves about what we need. What we need to continue living is right here. No matter the source or cost of our needs, we will continue living.
“Means” is the newly added category! Because our needs are so concretely defined (and can’t be changed), means helps us codify purchases based on the way we fill those needs. “Means” represents the means by which we fill these needs, or more accurately, how we currently want to have our needs filled.
For instance, grocery purchases, McDonald’s, and Ruth’s Chris are all means of providing food. But when we see them grouped as providing the same need, we may realize that going to McDonald’s more often and Ruth’s Chris less often, will save money. Going to the grocery store, however, may save us even more money and will be healthier than McDonald’s. The qualitative properties of our purchases are juxtaposed to the qualitative properties of the purchase in the context of the need fulfilled by these purchases.
To save money on food, we can live on only beans and rice, but we probably value a more expensive and more diversified diet. This is 100% fine! By understanding our consumption in this way, we are consciously making thoughtful decisions based on what we value overall rather than what we want at the time. This allows for long term planning. It puts better meaning behind telling ourselves, “No.”
The magic of the “Means” category is that it arranges purchases by substitutability. We can see the many ways we can deliver the same need, and then we need to exercise our self-discipline to delivering these needs rather than lying to ourselves about what we really want. We can make substitution decisions based on what we value, rather than on what we want.
“Wants” are pretty much unchanged. There should be fewer things in the wants category simply because we understand the needs category better.
By giving our day-to-day “Means” purchases a concrete definition based on “Needs”, we can now see how our “Means” spending affects our ability to consume our wants. “Wants” can now be contingent on our successful substitution and value-based prioritization of other budget categories. We can put off our “wants” until we have enough money for them. Or we can more aggressively substitute cheaper “means” to more aggressively pursue our wants.
With this method, we see how our “Means” can be substituted for each other to support the lifestyle we value, and our “Wants” can be substituted by our “Means” based on goals. Understanding our purchases in these terms, we can more mindfully and deliberately consume. Over time we are able to refine what purchases really matter to us, and which could be substituted for a cheaper substitute.
Another benefit of this method is that all of this can be understood at any income level. Lower-income requires more aggressive money-saving “Means” and fewer “Wants.” By seeing purchases in terms of acceptable substitutes, we can more fully focus on the quality of our decisions and lifestyle rather than the quantity of resources we have to dedicate.
I feel I need to speak to this in the context of budgeting. This is where things can get a bit more complicated, but if we remember how “Means” works, it is the same concept.
For 99% of the population, the real “Means” by which we fill our needs, isn’t food, or fuel, or shelter. It’s money. Money buys everything. Unless you are homesteading, the real means by which you acquire everything is actually money.
So, if this is our means, how then do we understand costs and opportunities associated with income? We can look at resources that support our income activities as means to that income. To generate income, do we “need” a car, truck, cell phone, personal assistant, or country club membership? Yes or no, depending on career and opportunities.
As far as income is concerned, the resources we have to spend to earn income are time, money, and energy. Any one or two of these can substitute for the others. For instance, if you put in time and energy, you can create something worth money. If you put more energy into something, it can save you time. Or with time, you can earn interest on money without energy.
Just as “Means” allows us to identify substitutes for our needs, time, money, and energy resources act as substitutes for income. This can go deeper to include education costs, career development activities, and working late for special projects. Are these really a good use of your resources as far as return on income goes? What is the balance of using or conserving these resources to achieve qualitative and quantitative harmony?
Avoid Feeling Poor
I was once talking to a close friend of mine from high school. She confided that her husband was having health problems that were keeping him from completing valuable training. So he would continue to work at a low paying job until he was well enough to complete the training. Also, they had three kids and were pregnant with their fourth. I asked her how they were making ends meet, and she described for me all the money-saving things they were doing, and how they were cutting out the fat. I am always blown away by how resourceful people can be when they need to be.
But then something surprising happened. I made a small joke about generic macaroni and cheese, and she said, “Absolutely not! My kids do not eat generic macaroni and cheese! We only eat Kraft!” I was shocked by this at first, because Kraft is much more expensive than generic, and in a family with 3.5 kids, that adds up.
Then I remembered something that I had learned years earlier when I lived in the inner city in Memphis. There I lived with lots of poor people, trapped by circumstances and lack of opportunity as well as long term consequences of poor decisions. As I talked with them and visited their houses, I noticed that they each had a way of doing something that didn’t make them feel poor.
I came to realize that I do this same thing. If I can’t eat out once or twice per month, I feel poor. When I feel poor, then I hate how I am managing my money, and I am tempted to give up on my budgeting and just go blow a bunch of money on whatever I want at the moment. I have found that even a single one of these moments can ruin months, or even years, of disciplined spending. And so I learned to add something to my budget that made sure I didn’t feel poor.
For my friend, it was Kraft Mac and Cheese. For me, it is an occasional night dining out. For many of the families I saw in Memphis, it was a big-screen TV, or smoking pork every weekend, or making sure avocados were always on hand.
At one point in my life (because I am a number nerd), I did a statistical analysis of my impulse purchases and statistically modeled my impulsivity so that I could create an “impulse” category in my budget to cover things I wanted in the moment for no good reason. It doesn’t matter how you do it, as long as it is modest and meaningful.
These small indulgences remind us that we are doing ok and that we can enjoy these simple pleasures because of the discipline we otherwise have. For me, these indulgences reinforce the feeling that I am not poor. Instead, I value this economic restriction because it makes me happier, and I believe this is an important reminder.
At other times I have attempted to be incredibly restrictive to save money quickly or make things last as long as possible, and I eliminated all excessive spending and forced myself to a regimented, joyless life. No matter how much motivation I could muster, I always cracked at some point and would find some way to binge spend.
I have found that a key component to staying within my budget, is making sure I am happy with my budget. My budget needs room enough for something that helps me feel like I am not poor, even if I am. Understanding the emotional elements of money is key to managing the emotional energy required to tell myself, “No.”
To summarize, spend less than you have. It is the only way to financial security. Your ability to tell yourself “No” is what we need to develop to follow this rule. Understand what needs actually are and that your purchases are actually the means of providing those needs. These means are fulfilled in many ways that can be substituted. Wants and means can be interchanged, and the goal is to achieve balance in all things. Income is a matter of applying time, money, and energy to our various opportunities. Understanding your return on these assets can protect you from wasted time, money, and energy. And find a meaningful way to remind yourself that you are not poor. Simple pleasures found in modest expenses, in the long run, can save you lots of money if it means protecting yourself from frustration with your budgeting system. If you don’t enjoy budgeting, you won’t do it. Be sure budgeting leads to balance and assurance; otherwise, you won’t stick to it.
Your financial future starts today
Savology has helped more than 40,000 households across the United States improve their financial well-being by providing comprehensive digital financial planning. Users can get started with our free financial planning or premium monthly planning memberships, allowing them to build a personalized financial plan, holistic report card, personalized action items, and more. In addition to our consumer-facing platform, we’re helping employers across the country provide their employees with effective financial wellness benefits.