The Three Basic Money Groups – And Why So Many People Struggle With Their Personal Finances

Just this morning, I was leafing through Jonathan Pond’s very good personal finance book Grow Your Money, which I reviewed a while back. In it, he makes the astute statement that everyone puts their money into three basic groups: necessities, luxuries, and saving for the future. The more I thought about that statement, the more profound I thought it was, as it builds a pretty strong framework for the financial problems ailing many Americans.

Obviously, the pile that will get you in the best shape over the long term is the “saving for the future” pile, but that’s only the first piece of the problem. The reason so many Americans are in poor financial shape is that they put more than they should into one of these areas to the detriment of others. Let me show you what I mean.

Some put money in the “luxuries” pile instead of the “saving for the future” pile. These are often the same people who argue that you only live once and that you’re wasting your time saving for the future when you could be enjoying the high life now. Quite often, these people realize what they’re doing – they know that they’re spending money on luxuries. The catch is that they just don’t care. I myself was in this group of people not too long ago.

Others put money in the “necessities” pile that should be in the “luxuries” pile. They identify things like HD televisions and cell phones as necessities in their life when the truth is that most of these things are luxuries. I have several friends in this group – they’re barely squeezing by and they are putting a little money away, but they continually tell me that they’re doing everything they can and are living “bare bones” as they surf the web on their G3 cell phone.

The recipe for success that I’ve found in life with these three piles is this:

First, go through everything in the necessities pile and determine if it’s really a necessity. In other words, go through every bit of your spending for a while and figure out whether you really need this item. I’m not suggesting going without the item, but merely determining whether you truly need the item for day to day life. Is that cell phone a necessity? For some people it may be, but are the unlimited text messages a necessity, or the web access features on it? Is that giant television a necessity? Is a case of beer or a $20 bottle of wine a necessity (they both are often included as “food” for some people)? When you start asking hard questions like this, it often becomes clear that many things in life are luxuries. Also, you begin to find that frugality is pretty cool – it shrinks the cost of many things in your necessities pile.

Then, try to keep a balance between luxuries and saving for the future roughly in balance. If you bring home $1,000 a week and spend $400 on the things that are truly necessities (mortgage, insurance, food), that leaves $600. Just put $300 of that away and spend the other $300 on the things that bring you pleasure – good food, good drink, technology goodies, and so forth.

Financial discipline is not about denying yourself everything enjoyable in life. It’s about finding a balance between the things you enjoy now and the things you’ll need later, and it’s also about finding value in all of the luxuries in your life rather than just treating them as things you do naturally.