Updated on 02.25.08

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

Trent Hamm

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.

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  1. Keenan Parsons says:

    Its 3G nor G3 :)

  2. Graham Lutz says:

    I think that the act of being disciplined financially brings joy in itself!

  3. Bill M says:

    “All Your Worth” by Amelia Tyagi and Elizabeth Warren proposes a similar split along with recommended sizes. Their suggestion is to strive for 50% in the “needs” bucket, 20% in the savings bucket, and 30% on whatever you want. They define the needs very narrowly to be those things that you truly need to live in safety and dignity. That filter may not work for everyone, but if you’ve got a 3-6 month emergency fund and your needs only eat up 50% of your take-home, you can last 6-12 months if something really bad happens. I’d highly recommend the book.

  4. I agree with Graham – I find joy in saving money and growing wealth.

    I don’t think that that it has to be difficult either. I make the necessary provisions for my basic needs and have that amount automatically transferred from my chequing account to my “bills” account each pay period.
    I also have my required investment amount automatically allocated to my investment account each pay period.
    Of the remaining money, I simply take half and put it in a “Rainy day/emergency fund” and use the other half for spending.
    Some months I find I have money left over and that money goes to my “Secret Stash” which I use for vacations and frivolous items once a year. This is basically a reward to my family for exceeding our budgetary goals.
    Great article – it really hit home with me!

  5. Stephan F- says:

    Needs vs Wants can be a struggle for many. This is a good way of doing it. Sometimes though some may end up in both categories. For example clothes: everyone needs some basic clothes but some people like spending extra on clothes. So realizing that can be helpful too.

  6. Di Di Ross says:

    My husband and I are trying to dig ourselves out of a mountain of debt–again. It wasn’t all that long ago that we were debt free, except for the mortgage on our home. After our son was diagnosed with an inoperable brain tumor, everything fell apart including our finances. Although he is a patient at St. Jude Children’s Research Hospital, where all of his medical expenses are covered, we were unable at that time to really make good decisions elsewhere. Now that he is doing better and we have adjusted to life with a chronically ill child, we are attempting to get back on track. We are having to reprioritize our spending, and I am amazed at how easy it has become to forget what the difference between a necessity and a luxury is. Thank you for this refreshing article today. It reinforces everything that we already knew!

  7. Steve Olson says:

    There is a fundemnetal problem with assesing needs and wants. I had a long discussion with a famous economics professor about this subject and he said he has come teach students that there are no neccessities. All things you buy are luxuries. And the langer the conversations went on, the more I realized he was right. Almost everything we purchase are luxuries. I suppose we need air, water, food, and shelter to survive, but in modern western society all there things have levels of luxry to them. Some say education is a neccessity, but it isn’t. I’ve heard people say getting into a top 50 college is a neccessity. Some people say a computer and telephone are neccessities. I lived just fine for many years without those things and I know people who still do. There is no “need” and “luxury” pile. They are essentially the same for all of us at almost every income level, they are all luxuries. You just “think” you “need” these things, but you can choose to “think” anything you “want.”

    I know it is hard to swallow, but I think it is a fundemental truth about our fabulously wealthy society. We just don’t want to admit how rich we really are.

  8. Frugal Dad says:

    It’s good advice to recommend a balanced approach. I’ve always appreciated that about your site, as some PF blogs recommend one extreme or the other (spend/save). You can only cut so deep into spending before it starts to really hurt. If you grow to resent your own plan you will ultimately scuttle the whole thing and revert back to spending money like water.

  9. AaronO says:

    I think everyone’s wants exceed their needs. I believe the problem is a person’s patience level. Being financially responsible and frugal will pay off over time. But by using credit and going into debt, you can have the immediate satisfaction of having those “wants”. It’s like investing. Paying your debt and saving your money will have larger returns over time. Plus you can save more money with less debt allowing you to actually afford those “wants”. Patience is a virtue.

  10. Sandy E. says:

    I used to have a problem differentiating needs from wants, until I changed those words to essentials and nonessentials.

  11. Shareef says:

    Trent, thanks for this post. I’ll be debt free (except for student loans) in Aug, and one thing that I struggled with early on was trying to put ALL of my money toward debt. It was more of a Dave Ramsey focused approach. Unfortunately, that approach led me to be frustrated and would cause me to sometimes spend even more on luxuries than I normally would. Once I developed a budget and gave myself a little fun money, I was right on track. Thanks for all of the work that you do!

  12. Be careful what “luxuries” you sample. I had a wise person once tell me tat. He said, “A luxury, once sampled, has a tendency to become a ‘necessity’.”

  13. I think it’s important to save a pile for the future, but let’s not forget the importance of living for the now too. Even seemingly luxury expenses like pricey once in a lifetime Superbowl tickets are worth the cost of the experience. Those are quasi necessities that make life great. Spend on memories, not material things I always say.

  14. KC says:

    I think I’m just a lucky person cause I am wired differently. For instance I see my cell phone as a detriment. Sure, I have one for emergencies, but its a cheap pre-pay that costs me $80/year. Why is it a detriment? Cause I hate talking on the phone and my mother and husband both call me all the da– time. I just keep the phone off unless I need it.

    Same with the flat screen TV. My tv gets a great pic with the digital signal we receive. Whereas if you don’t also buy the HD signal when you buy the flat screen you get a pretty crappy picture. Also flat screen TVs can “walk” out of your house a lot quicker then the huge old ones. The old ones don’t have much pawn shop value and aren’t going to make your home a target to thieve. I know several people who have had their homes broken into and the only thing stolen were the flat screen tvs – its a problem.

    For some strange reason I like and am happy with a simple life – I’m not a hermit, by any means, but I just like things uncomplicated. And its a whole lot cheaper.

  15. Tomski says:

    I would first pay off any short-term debt you might have. That means if you took on some loan to buy that HD tv. After that is sorted out start saving. But also start saving for your pleasure things. It feels much better paying you HD tv cash than with a loan.

  16. Minimum Wage says:

    All needs and no wants makes one grumpy.

  17. kleanchap says:

    It is the luxury items that get to me. The few that I buy are expensive and top of the line. It mainly the reliability factor for which I do not mind spending a few extra dollars.

  18. EJ says:

    I come at this problem from the other extreme: no matter how much money I save, it can feel like it’s never enough. It’s interesting that I’d been thinking about this very problem today.

    I work in a grocery store so my lunch is usually whatever free samples are available, but the free sample lady was off work today, so I didn’t get anything and spent the rest of the day hungry and miserable. I know it’s crazy, but I just couldn’t make myself buy something to eat.

    I think I need a reverse budget – set aside an amount of money that I MUST spend every month.

  19. colonel cash says:

    Needs, wants, and, haves. We all need what we need, live for what we want, and in our hurried lives, lose appreciation for what we have.

    Maybe if we took a little time enjoying that which we already have, we wouldn’t be quite so inclined to think about what we want.

    Perhaps we already have what we need…

  20. Nicole says:

    My fiance and I are expecting a baby boy any day now. And due to a lot of circumstances, including the impending birth of our son, we have taken a long, hard look at our finances and are making some difficult but worthwhile changes. Reading this post just reiterated the importance of dilligence, determination, and self-rewards during this process. It is a fine balance of these characteristcs that will bring us to our ultimate goal- financial freedom.

    THanks for the post- I love this blog!

  21. daydreamr says:

    Steve makes an interesting point that everything we spend on is a want. I agree to a certain extent. If you compare what it takes to survive and what it takes to live according to standards of society, there is a big difference. Of course we all can’t grow our own food and live with out certain utilities. I went without power for a while and didn’t miss it. However, now that I have it back, it is a luxury that I prefer having. I went without car insurance and saved more in the process even compared to the fine and small increase in my insurance once I got caught and was forced to comply w/the laws. But things like TV and especially cable are not needs by any means. Then there are the things that make your life easier. I bought a GPS and now I don’t know how I would ever live without it. It keeps me from getting lost. Of course the $200 could have gone into a savings account…The fact of the matter is that people get addicted to spending money. They also get addicted to many things that are not drugs. TV is an addiction as is eating fast food, gambling, excercise (although it’s healthy, paying for a monthly gym membership could be considered a luxury). Like exercise, there are a lot of double standards. We need food for survival. But do we need to buy the very best name brands and organic/natural products? Sometimes labels are misleading and cause people to justify spending the extra buck on something.

  22. Betsy says:

    Just after college I made up a simple budget for myself that has worked well for me. All money that comes into my life gets divided into three pots: 1/2 into checking, 1/3 into saving and the rest into cash to be spent as I wish. Or “live on half, save a third and spend the rest”. It sounds impossible, but most people earning greater than minimum wage can live on half.

  23. kathryn says:

    daydreamr brings up an interesting point…wants vs needs ends up being very personal. (Mandatory auto insurance is optional but you cannot live without a GPS?)

    I think Trent’s point was that we should each examine the balance between our needs and wants, but I’m sure it is also important to examine our categories carefully. And remember, we are good at rationalizing almost anything. Among the things that I’ve turned from “wants” to “needs” are a gym membership (keeping us healthy) and cell phones (to be reachable by wandering teenager.) Oh, yes, and my internet connection, so I can read the The Simple Dollar. ;)

  24. AnKa says:

    I think this is indeed a very astute observation about the 3 ways to use money. And I agree with many other responses that the definition of ‘need’ is ridiculously warped in our society. I have had people tell me in all seriousness that manicures are a ‘basic need’. As in ‘there is no reason to let yourself go even if you’re not rolling in it’.
    I think it is important to count your blessings every day.
    I have a cleaning lady, that I will tell anyone who asks, is the best money we spend. But don’t get me wrong – I do not consider her a necessity!

    Realize how many ‘wants’ you already have in your life, and maybe you get enough satisfaction out of that presumably long list that you can deny yourself the splurge you were about to make thinking ‘I deserve it’.

  25. tabuxander says:

    Temptation is like a desease to us. Sometimes we don’t really want to buy luxurious items. We try so hard to fight but in the end we lose the battle.

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