With the Balanced Money Formula, there is always enough for Must-Haves (50%), Wants (30%), and Savings (20%). This 50-30-20 money plan from Elizabeth Warren and Amelia Warren Tyagi, authors of All Your Worth, covers all your financial concerns for long haul. Ready to jump in?
Why 50% for Must-Haves?
That’s the first question most people ask. The Must-Haves get only half your money? Half? How can that be? Are we saying you live on only half your money? Not exactly. We’re saying you should limit the hard-core commitments to at most half of your income. Remember, Must-Haves are the things you will have to pay no matter what.
But you may still wonder, if these are Must-Haves, why don’t they claim 60%? Or even 80%? After all, how can it be wrong to spend money on things you Must Have?
Why 50%? There are three simple reasons.
1. It is sustainable. Anyone can live on rice cakes — for a day. Anyone can hold her breath — for fifteen seconds. And anyone can spend everything on the rent and the car payments — for a very short time. All Your Worth is not about getting straight with your money for a month; it’s about getting straight for life. A diet that works for only a day is as worthless as lipstick on a pig. A spending plan that works for only a month is worth even less.Spending 50% of your income on Must-Haves is sustainable. It leaves you with plenty of money for the rest of your life. Enough for fun, and enough for the future — enough to last a lifetime.
2. It is safe. When everything is going well, you should have money for what you Must Have and for what you Want. But let’s face it, over a lifetime, things don’t always go according to plan. Sometimes the rain falls and you don’t have an umbrella.
Money balance is the key to keeping you safe when things go wrong.
Suppose you get laid off. That’s no fun to think about, but we all know it could happen. If your Must-Haves take only 50% of your income, then how would you fare? A lot better than you might think. With Must-Haves at 50%, your unemployment check could cover your needs for several months. (In most states, unemployment insurance covers roughly 50% of your previous salary, up to certain limits.) Knowing you can cover the basics should take some of the terror out of the pink slip! Likewise, if you were in a serious accident and you couldn’t work, most disability policies would cover about half of your salary, and so your basic needs would be met. And if you are married, keeping your Must-Haves at 50% means that you could get by on only one paycheck for a while.
Keeping your Must-Haves down to 50% gives you something that is so incredibly valuable: flexibility. If your Must-Haves creep higher — say, to 70 of 80% — there just isn’t much room to maneuver. There’s not any space to scale back, nowhere you can cut if you need to. But if you can get by on 50% of your income, you have the flexibility to cut back on your spending whenever you need to. You are in control. You can manage an unexpected expense like a car accident or a leaky roof. You’ll be okay if your boss cuts your hours. If you keep your Must-Have expenses under 50%, you can stay light on your feet, ready to roll with the punches.
3. It has been tested over time. We go back to 50% for the Must-Haves because that number worked for Americans for a long time. A generation or so ago, most families spent half (or less) of their incomes on the Must-Haves. As a result, most people were able to put money away, each and every month. Unlike today, saving was the norm. We go over the details in The Two-Income Trap, but the bottom line is this: Bankruptcy rates were low, foreclosures were rare, and few people even knew what a repo man did for a living. Getting rich, little by little, was commonplace; people did it every day. People also worried less — a whole lot less. They knew they could make it to the end of the month, and they knew they had plenty of money for a rainy day. So they slept easier and smiled more. Not a bad model for us to learn from today!
Why 30% for Wants?
Why 30% for Wants? Because you deserve some space where you can relax and enjoy yourself! This is what life is all about, the right-now reward for all your hard work.
This is the place for all the treats and extras, the things that give life spice. A new set of speakers, plane tickets to Grandma’s, aerobics classes, Christmas presents, and on and on. These are bought with “fun money,” the free money set aside for your Wants.
Unlike the Must-Have category, which is very restrictive in what gets included, Wants is a totally open field. Maybe your fun money goes to Duran Duran CDs and Kevin Costner films. Maybe you prefer origami lessons and Swedish massages. Maybe you think other people’s Wants are boring or dumb or icky, while your Wants are cool, sensitive, or socially responsible. Be that as it may, the fact remains: You can spend your fun money on anything you want. Anything at all; it doesn’t matter one bit. If you want to spend it piercing your belly button and playing the slots in Vegas, we won’t raise an eyebrow.
The fun is almost unlimited in choices. Dresses or Ding Dongs, dog treats or daffodils — whatever strikes your fancy. There is only one rule: The Wants category has a lid — and the lid is clamped down tight. There is no limit on how you spend fun money, but when it is gone, it is truly gone. No fudging around the edges. No borrowing against next month’s fun money. No nibbling out of the Savings. You can safely spend this much, but no more.
A spending cap can sound so dreary, full of denial and no-no-no. But this cap is all about liberation, not deprivation. When you know that it is okay to spend because the limits have been worked out, then you really can enjoy your money.
Setting aside a specific amount for your Wants is the key to breaking the cycle of crash-diet-budgeting. It puts an end to those fits of good intentions when you suddenly declare you Must Clamp Down On All Extra Spending Immediately. Talk about the road to misery! It’s like telling yourself that since you need to lose weight, you Must Never, Ever Eat Anything But Raw Vegetables. It’s impossible to live like that for very long, so either you deny yourself all the time and feel lousy, or you splurge and feel guilty. Either way, you are perpetually caught between the two sides to the trash compactor: misery from constant denial and guilt from having fun. You always feel bad about your money and, since you’re never quite sure how to get caught up, you don’t get any closer to a real solution to your problems. The Balanced Money Formula helps you break that cycle.
By figuring out now what is a Must-Have and what is a Want, you make it very easy to follow the golden rule of financial responsibility: Pay your Must-Haves first. The Wants should never, ever compete for money with your Must-Haves. In other words, when everything goes well, there is money for Must-Haves and Wants. But if something goes wrong, the Wants are the first thing you cut. There is no money for a trip to Las Vegas or a new set of speakers until the car payment and the rent are paid. You already know this, but saying it out loud today makes it a lot easier to cut right to the chase should the need ever arise. If that rainy day ever comes, you’ll know right where to head for shelter.
The Balanced Money Formula helps you create a prominent place for the money you spend on your Wants. No guilt, no worry, just fun. It’s grounded in reality, because it starts with what you earn each month. It’s safe, because you spend it after you’ve set aside enough for your basic needs. And it’s worry-free, because you’ve given yourself 100% permission to spend it. You’ll be surprised how much more fun this spending can be.
20% for Savings — Are We Kidding?
Savings comes at the end of the Balanced Money Formula, rather than at the beginning. That isn’t because Savings isn’t important. It is! Savings comes at the end so you know how to find the money to save. All Your Worth makes Savings really, really easy. Think about the formula: 50% for Must-Haves and 30% for Wants. That means that the 20% for Savings is automatic; it just happens. Once you get the plan in place and you bring Must-Have and Want expenses into line, you will have your 20% left over for Savings. No need for a Herculean “we have to tighten our belts so we can save for a house (or the kids’ college or whatever).” No boom-and-bust bank account. Just a simple, steady, month-by-month plan to build your wealth.
So why 20%?
So you can stop worrying
Maybe you’ve felt it. The rush in the pit of your stomach when you hear the pinging sound in your car, and you wonder how you’ll ever pay the mechanic. The tightness in your chest when the plumber tells you it will be $185 to fix the shower. The rock-hard knots in your back when you realize that the check you mailed to the electric company will probably bounce.
These are the feelings of not having any Savings. And when you start to save — when you really sock it away, month after month — these feelings stop. You can put these feelings in a box and mail them to the moon, because they won’t be with you anymore.
Setting aside 20% of your income will put some money in the bank fast. You will build a cushion that is there when you need it. This cushion will let you end — once and for all — the worry over life’s little financial emergencies. It will take a lot of the sting out of things that go wrong, because you will know that you can manage. When you have some money in the bank, you can relax. In other words, Savings isn’t just about living better tomorrow — it is about living better today.
ABOUT THE AUTHORS
Elizabeth Warren is a chaired professor at Harvard Law School. She has appeared on numerous television shows, including Dr. Phil and the Today show. Amelia Warren Tyagi, is a former consultant with McKinsey & Company, and has written for Time, USA Today, and several other publications; she is also a regular commentator on Marketplace. Elizabeth and Amelia are mother and daughter coauthors of All Your Worth: The Ultimate Lifetime Money Plan (Copyright © 2005 by Elizabeth Warren and Amelia Warren Tyagi) and The Two-Income Trap: Why Middle-Class Parents Are Going Broke.
MORE ARTICLES BY THE AUTHORS
- Read the Introduction to All Your Worth: The Ultimate Lifetime Money Plan
- See the book’s Table of Contents
- Learn more about the book