Follow Elizabeth Warren’s Excellent Budgeting Advice
Prior to becoming Senator and 2020 Presidential Candidate, Elizabeth Warren was a professor at Harvard, and she also had a chance to write a couple of really good books on personal finance and economic instability in the United States.
Indeed, her first book, The Two Income Trap , (co-authored with her daughter, Amelia Warren Tyagi) highlighted many of the economic issues we still deal with today, like the rise in housing and education costs, stagnant wages, hollow out middle class and so on long before they became the daily fodder for the largest newspapers in the country.
She and her daughter are also planning some policy changes that could help reduce the financial burden on middle-class families, including those she made during the presidential campaign. It’s worth reading, but I really want to talk about her other book, All Your Worth , also co-authored with her daughter. In many ways, this is a fairly simple book on personal finance, but what is special about it is that it was this book that pioneered the 50/30/20 budgeting system, which is now being promoted by many financial experts (Lifehacker commentator, Antifaz). originally got my attention for this book, so thank you for that!)
In All Your Worth, Warren and Tyagi write that the key to managing your finances is not drinking coffee here and there, or just shopping in the sales section, but rather balance . Now this is nothing new – in fact, I write a lot about it – but when their book came out in 2005, there was not as much quality financial information as there is today. They write:
Most of the budget starts at the edges and works on a “cut here” and “cut there” principle. It’s a bit like planning a diet by saying “cut cookies” and “sugar-free coffee.” This approach may or may not work with minor modifications, but it is not a complete life plan. And if you don’t have a master plan, cutting down on multiple expenses in one place while spending too much money elsewhere won’t do you any better than cutting out donuts while you gorge on cupcakes.
We start with a completely new approach to money. No complicated lists. No expense diaries. Instead, we will help you analyze your expenses by dividing them into three simple categories. There is one category for your regular monthly bills, a second for money you spend “just for fun,” and a third for savings.
These three categories make up a 50/30/20 budget: 50 percent of your money goes to needs or needs (housing, transportation, food, bills), 30 percent goes to discretionary spending or wants , and 20 percent goes to savings. …
As long as they write, this plan works because it is a lifelong plan; there is no get-rich-quick scheme. Instead, over time, you struggle to stick to these categories in order to always stay in a fairly comfortable place. Obviously it is possible (and in some cases necessary) to deviate from the formula, but it is for most people.
New definition of “must” and “wants”
One of the keys to this concept is how Warren and Tyagi define needs and wants. As they write, the “rules of the game” have changed in the last one or two generations (and this point is clearly visible in the “Two Income Trap” ). As they do now, they say:
You can get too big a mortgage, and banks will help you with this. You can rent a car that eats up half of your income. You can get a student loan more than some home mortgages. And as confident as the sky is blue, you can accumulate credit card debt without batting an eye, even if you don’t have 50 cents to pay.
This does not mean that it is impossible to achieve the correct monetary balance; it just means that you need to know the rules – and doubly aware that the bank, your credit card company, student loan service, etc., are not ready to help you.
And, as they write, “If you’re not saving enough, it’s because you’re spending too much on your Wants or Must Haves (or both).” And there is some consolation in that, because once you can find the right balance with your desires and necessities, “you will start saving automatically.”
But when most people roll their eyes and check, they’ll probably hit 50 percent on Must Haves. Only 50 percent of your paycheck for rent, transportation, food, insurance, etc.? In this economy? But, as Warren and Tyagi write, that number is possible. Must Haves are your “hard commitments” that you have to pay no matter what.
Let’s say you got fired. It’s not fun to think about, but we all know it can happen. If your must-Haves only took 50 percent of your income, how would you feel? Much better than you think. With 50 percent Must-Haves, your unemployment check can cover your needs for months. (In most states, unemployment insurance covers about 50 percent of your previous paycheck, up to a certain point.) … Lee Q: If you have a serious accident and can’t work, most disability policies will cover about half. your salary, and thus your basic needs will be met. And if you are married, then 50 percent of your must-Haves means that you can only live on one salary for a while.
Keeping what you need to have at 50 percent of your income gives you flexibility, which gives you some power and control. If your needs only require 50 percent of your income, you can easily cut other expenses in an emergency.
On the other hand, your desires can be almost what you want, as long as they do not exceed 30 percent of your expenses. This includes things like cable TV, Netflix, haircuts, dining out, concerts, birthday / Christmas gifts, and more. “Spending limiting can sound so dull, full of denial and banning-no-no,” – they write. “But this cap is about liberation, not deprivation.” You can have more fun with your money if you know that all of your bases are covered.
And, just like having control over your essentials, it gives you more freedom and flexibility.
“Allocating a certain amount for your desires is the key to breaking the emergency diet budgeting cycle,” they write. “When you suddenly declare that you must immediately stop all additional spending, it will put an end to fits of good intentions.” That’s what’s really dreary.
Start small
The book explains how to achieve balance, how to achieve most other monetary goals, and also learn about the pitfalls that you can fall into. I wanted to highlight one “pitfall” that I often see in my own interviews / conversations with friends, etc., this is an all-or-nothing approach to money and investing. They write,
I will never be limited by a budget.
My credit is messed up, so why bother? I always have a balance on my credit card.
Never. Is always. Forever. These are the hallmarks of all-or-nothing thinking. All-or-nothing thoughts boil down to one thing: if I can’t be perfect, there’s no point in trying to get better. One little mistake, one little mistake, and it’s all over but crying. Exit on first error. Sounds familiar? Over the years, we have seen how the concept of financial balance provokes an all-or-nothing fatalist attack in otherwise intelligent people. “I will never cover my must-Haves with half of my income! I can’t save $ 2, let alone 20%! “You may feel the same way. Maybe you’ve looked at this 50-30-20 formula and you wanted to throw this book against the wall and shout, “I can’t do this!” … [But] think of it this way: if you can change even A. 60-40-0 budget to 55-30-15 plan, you will be much better off. Of course, you will not be perfect. But you will start to move forward every month. Moreover, with such numbers, in a few years you will be in a better position than the vast majority of Americans. And this will be something to be proud of.
This is why I emphasize the need to start small and build . Yes, unless you are saving or investing yet, you are unlikely to reach your goal overnight. It’s impossible. But it doesn’t have to be all or nothing – if there is anything that money / addition shows us, it is that small changes can equal big results. Again, we are not playing a short game here. There’s a lot more in the book, including worksheets and exercises, so if you’re interested in a basic PeFi book, I recommend it (and the index card by Heline Olen and Harold Pollack, who has a similar vibe). I can’t wait to see what other botanical suggestions Warren has in this electoral season.