So you're starting improve your finances and you're hearing a lot about splitting your expenses into needs vs wants. Why would you do that, and how can you clearly tell between them?
Needs vs wants refer to the distinction between essential expenses and discretionary expenses.
Needs are basic necessities that must be met in order to maintain a certain standard of living, such as food, shelter, clothing, and healthcare.
Wants are non-essential items or services that can be purchased with extra money after needs have been taken care of. Examples of wants include vacations, entertainment, luxury items, and dining out.
Why is it good to differentiate between needs and wants?
It is important for your financial future that you can tell between needs vs wants because it helps you prioritize your spending and ensure that essential expenses are taken care of first.
There are many reasons that this skill is important.
It ensures your basic needs are met
First, it helps you ensure that you are not overspending on non-essential items or services before taking care of the basics.
It keeps you out of debt
You get to stay within budget and avoid accumulating debt, which can have a negative impact on your financial future.
It helps you save more
Lastly, you save more money in the long run by purchasing only what is necessary. You leave more funds to invest or save for your long term goals.
When would you differentiate between needs and wants?
There are two key situations when you would differentiate between needs and wants:
For budgeting
When budgeting, putting money aside for needs is non-negotiable. You need to have money for these things in order to survive. On the other hand, you can afford to put off spending on wants.
By budgeting this way, you can ensure that you're not neglecting your needs while not overspending on your wants.
Imagine if you thought that luxury vacations was a “need” and you prioritize saving for it over paying for your utilities. Your electricity might be cut, and that would drastically affect your ability to work and live.
When Spending
When faced with spending decisions, knowing if you're if it's a want or need can help you make the right choice.
For example, you have limited funds and you're looking at a new pair of shoes – should you spend on this or not?
If this is a want, then you can hold off on buying these shoes until you're sure that all your basic needs are met for the month. Or you might buy the shoes by using your “wants” budget, knowing that you have less to spend on other “wants” after this purchase.
Examples of Needs
Some examples of needs include food, clothing, shelter, and medication. These are essential items that are necessary for survival and should be prioritized over wants when making spending decisions.
Examples of Wants
Examples of wants include entertainment items such as video games, movies, or books; luxury items such as jewelry or designer clothing; and recreational activities such as vacations or sports equipment. These are items that we may desire but do not necessarily need in order to survive.
What if it's hard to tell if it's a need or want?
Grey areas between needs and wants happen all the time. When that happens, you can ask yourself three questions that can make things clearer.
Here's what you can ask yourself to tell if it's a need or a want:
- Is this necessary for survival? Will not having this thing deprive you of your basic life needs like eating, sleeping or earning an income? If so, it's a need. Otherwise it's a want.
- Is it a one-off expense? Wants usually show up as one-off expenses, because they're not something you need month to month. You pay for most of your basics regularly, like your utilities and groceries. While it's a decent rule of thumb, this is not a hard and fast rule. For example, your gym memberships and Netflix subscriptions are wants that are charged monthly.
- Can I delay having this thing? Are you able to put off having this thing without dire consequences? If you can't imagine putting the purchase off for another month or two, it's probably a need. Otherwise it's a want.
So let's take a very tricky example – a leaky roof. Is fixing it a want or need? Let's put it through the questions:
- Is this necessary for survival? Maybe there's not a lot of water coming through the roof. It's unsightly, the wet patch is growing, but you're not so cold that you're not able to sleep. It's not necessary for survival. More like a want.
- Is it a one-off expense? Yes, fixing the roof is not a recurring cost. It could be a want.
- Can I delay having this thing? You could argue that left long enough, a wet house can get moldy, which is a health risk. But because it's summer and the days are dry, you think you could put this off for another month. So it's a bit more of a want right now.
Based our answers to the questions above we'd categorize the leaky roof as a want and not a need.
Isn't it important to fix the roof? Certainly. But it deserves another place in your budget, like your “savings” category. Now you can save up for it over a number of months using excess cash only after you've covered your needs.
Does that mean I should never spend on wants?
No, you should not completely avoid spending on wants. While needs are important, it is also important to treat yourself every once in a while. This is good for your mental wellbeing and is a motivating reminder of why you're budgeting in the first place – to achieve your financial goals, even the short term ones.
If you become too focused on saving money you may miss out on opportunities for growth and enjoyment. You can also start having feelings of deprivation or unhappiness, which are not sustainable long term.
Conclusion
Understanding the difference between needs and wants is an important financial skill. Needs are essential for survival and should be prioritized in your budget, while wants can be delayed or saved up for over time.
Remember that spending on wants is not always a bad thing – it can help you stay motivated and enjoy life. With careful planning and consideration, you can make sure your needs are met while still having some money left over for the things you want.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
