December 22, 2008

Prioritizing your 'wants' spending to maximize

I'd rather spend $75 on a nice dinner out with my wife than spend $75 on new piece of high end clothing. I'd rather spend $2,000 on a fun vacation than use the $2,000 towards a luxury car. I'd rather put $500 into a new computer upgrade than spend $500 on paying someone to mow my lawn for me.

We each have different priorities in what we enjoy in life. While my priorities place higher value on eating out, vacations and computer hardware someone else will appreciate nice clothes, high end cars and freedom from yard work more. There isn't a right or wrong answer in how you choose to spend your discretionary spending. The important thing is to prioritize your spending so that you get the most of what you want out of it.

Previously I discussed the idea of a Balanced Money Formula. That is where you make a rough budget dedicating up to 50% of your after tax income to 'needs' then spend the rest with up to 30% for your 'wants' and save the remaining 20%. If you follow this kind of budget philosophy then you have your savings covered with 20% of your after tax going into savings. Then you cover your basic bills and expenses with the 'needs' category. This leaves you a sum of money to spend as you see fit on your 'wants' items.

One key way to make this system work is to minimize your spending wherever possible on the things that don't bring you satisfaction. If you can reduce your spending on the 'needs' category then that frees more money to use towards your 'wants' or savings. Frugality and being conscious of your spending is important to meet this goal. If I can cut $10 a month off the cell phone bill or save $20 a month on our home utilities then thats an extra $10 or $20 a month that can be spent on things we enjoy or saved for retirement. But if I'm not careful about spending I could easily over spend on the basic bills and end up with $200 in cell phone bills and an extra $100 in utility costs. That kind of unnecessary spending wouldn't bring me any more substantial enjoyment in life and it would take money away from what I want to spend on the things I truly do enjoy.

If you define a 'wants' budget for yourself then this gives you a pool of money to spend on things you enjoy. Then it becomes a trade off between one luxury expense and a frivolous enjoyment. This will then lead you to prioritize your 'wants' spending items. Lets say for example that you make $60,000 annually and take home $48,000 after taxes. This leaves you about $4000 a month. If you use the 50/30/20 split then this means you'd dedicate $2000 to spend on 'needs', $1200 for 'wants' and $800 towards savings. (Keep in mind this is just for illustration sake and I'm not trying to define a realistic budget here) How you decide to spend that $1200 will depend on what you prioritize more. If you know you've got $1,200 in the budget then that gives you that much money to divvy up between eating out, fine clothes, manicures, sporting event tickets, vacation, new car payments, home remodeling, etc or whatever other 'wants' items you might consider. You can' afford everything you might want so now you have to make a choice as to which items you spend the money on and which will wait.

The more money you save on your expenses the more this frees up to spend on things you enjoy or to save for a rainy day. Defining a portion of your income for savings and discretionary 'wants' spending will give you a balance between responsibility and fun in your budgeting.

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