Rent, cell phone bill, dinner out, student loan payment, mortgage payment, a new pair of jeans, groceries, cable. Everyone’s budget is made up of expenditures of various importance. Some are crucial, it is impossible to live with without food and shelter, while others are completely discretionary, that food does not have to be from a fancy restaurant. After tracking expenses for a few months, you will begin to have a good sense of your monthly expenses. Now it is time to go through your list of monthly expenses and label everything as a want or a need. The goal is not to have only ‘needs’, but to have a better sense of how you are spending your money each month. Knowing this will allow you to calculate how long you could survive in a financial emergency, help you figure out ways to cut back if you are spending more than you earn and guide you when you need to make changes to your monthly spending.
In coming up with your list of needs and wants I challenge you be quite ruthless as to what you put in the need category. Think about what it is that you absolutely must have and the bills that require a monthly payment, and everything else goes in the wants category. Here are some examples of wants and needs from our monthly budget:
Needs : housing expense, cell phone, groceries, utilities, insurance
Wants: eating out, Internet, parking, entertainment, clothing, travel, gifts
Under needs are things that we could not live without. In a very extreme case, we could sell our house and move into a cheaper house or in with family or friends, but this would take a lot of time and is not likely. However, if my husband our I lost our job, it would be easy to stop buying clothes and cut way back on eating out and other entertainment. Debt payments always go into the needs category.
Some items fall into a gray zone. Groceries is a great example. If we really needed to cut back on our spending we could cut some, but not all, of our grocery bill by buying less meat, shopping at a different grocery store, buying less alcohol, among other things. Phone and internet are another example. I have cell phone under needs because we have no land line and I consider one phone line to be a need. However, if your budget includes both a land line and a cell phone, put one under want and one under need. The goal is not to have all wants or all needs as it is important to have a balance.
Now that you know how much you are spending each much on needs, it is easy to figure out how long you could survive financially if you lost your job. No one likes to think about losing their job but, especially in current economic environment, it is something that everyone should keep in mind. To figure out how long your savings would last after losing your job take your total savings and divide by your monthly ‘needs’. So if your needs amount to $1,000 a month and you have $10,000 in savings, your savings would last you for 10 months. This calculation assumes that as soon as you lost your job you would cut all ‘wants’ from your budget which is a rather extreme assumption so use this calculation as the upper limit of power of your savings.
Understanding what portions of your budget are going to wants vs. needs can also help you figure out easy ways to cut back on spending, either temporarily in a financial emergency, or permanently if you find you are spending more than you earn. It can also help to explain why you are having a hard time making ends meet yet feel as though you have a frugal lifestyle. If a big portion of your budget is coming from needs, leaving little room for wants, your monthly budget is going to feel cramped even if you have a lot of income.
Finally, I find it helpful to have a sense of where we could make quick cuts in our budget if necessary and it is always easiest to do this from the wants category. I also like to look through and make sure we are still getting value out of everything in our ‘wants’ category. For example, we recently had to start paying for daycare, something that is now our largest expense besides our overall housing cost. As we were preparing to add this to our monthly expenses, I went through all our wants and looked at ways we could cut back. We were spending over $100 a on a monthly gym membership that we were using regularly up until our child was born, but had not been since and had no plans to go in the future. This was an easy thing to cut.
The exercise of dividing your monthly spending into needs and wants can be eye opening and will force you to really prioritize your budget.