When you’re building a budget, one of the first pieces of advice experts will give is to divide your expenses into your “wants” and “needs” and base your spending on certain percentages of each. But how do you distinguish between the two?
For some expenses — like rent or a mortgage payment — it’s clear that it’s a need. Shelter is a basic necessity and cannot go unpaid. On the opposite end of the spectrum, retail therapy is clearly a want.
But what about grocery and dining out budgets? What about savings? For some costs, it can be hard to tell the difference. Plus, people have different definitions of what falls into each category.
[READ: How the 70/20/10 Budget Rule Works]
What Is the Difference Between Wants and Needs?
“Distinguishing between needs and wants for individuals, couples and families is an ongoing challenge. Why? Human beings are very ‘reference dependent.’ In other words, our environment determines our frame of reference for what we perceive to be a necessity versus discretionary,” Michael Liersch, head of advice and planning, wealth and investment management for Wells Fargo in New York City, says.
Linsey McKay, certified financial planner and owner of McKay Wealth Management in Tukwila, Washington, addresses this challenge.
“I categorize two of the main expense categories as everyday essentials (needs) and lifestyle (wants),” she says.
McKay says that everyday essentials include crucial expenses like mortgage or rent payments, utilities, food, gas, insurance and child care, and that “lifestyle expenses are splurges we choose to make, such as a nice dinner, a vacation, a luxury car or retail therapy.”
Determining between a want and a need requires figuring out which expenses are necessary to maintain a basic quality of life and which are bonuses.
[Read: Inside the Psychology of Overspending and How to Stop.]
Examples of Wants
Wants, nonessentials, lifestyle and discretionary purchases are costs that are not necessary to maintain your basic quality of life.
Michael Collins, chartered financial analyst and professor at Endicott College in Beverly, Massachusetts, says wants include things like entertainment expenses (dining out, going to the movies, subscriptions, etc.), vacations, lavish clothing and hobbies.
Examples of Needs
Needs, essentials and living expenses are things you can’t do without.
“Needs are expenses that are essential for a person to live and may include rent or mortgage payments, insurance premiums, utilities, transportation expenses and food costs,” Collins says. In addition, health and child care fall into this category.
How to Decide if an Expense Is a Want or a Need
If you’re having trouble deciding if an expense is a want or a need, you might need to talk with your family and define your values.
“It’s extremely important to outline your values in a family to determine the difference between wants and needs. You can have a family meeting around this very topic and ask the question, ‘What constitutes needs versus wants in our family?’ Don’t be judgmental — be honest,'” Liersch says.
For instance, higher education is a need for some, while others consider it discretionary spending, he adds.
Still, it’s a good exercise to look at your expenses and decide if you can still live a comfortable life without some of them.
Food purchases — think, groceries versus dining out — are a good place to start.
“When working with my clients we typically make separate budgets for groceries (essential) and dining out (nonessential),” McKay says.
The final division between the two might look different for everyone, based on individual needs, she adds.
“Cars are another great example. Having a car can be essential — you need it to get to work — but at what point does a car become a lifestyle expense? Setting your budget framework will help you determine what your necessary car budget is and if your car payment exceeds that, then you’re bleeding into lifestyle,” McKay says.
[READ: 10 Simple and Free Budgeting Tools.]
Dividing Your Budget and Why It’s Important
Both wants and needs are crucial parts of your budget, though you should allocate your money accordingly. Living a life with just the essentials works when money is tight but leaving room for spending that brings you joy still has value.
“The percentage of your budget that should be allocated to wants and needs will depend on your individual circumstances. Generally speaking, I would suggest that needs should take up at least 50% of your budget, while wants should take up no more than 30%. This will help ensure that you are able to meet your essential expenses and also have enough left for nonessential spending,” Collins says.
Most experts recommend the remaining 20% of your budget goes toward savings, but you can also adjust this number when things are tight. When you are able to put that money away, building a solid emergency fund is a top priority, followed by retirement and other savings goals.
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Wants vs. Needs In Your Budget ? How to Tell the Difference originally appeared on usnews.com
