What comes to mind when you receive an income or salary? Do you plan your finances beforehand? Do you plan in the short or long term? Knowing how, when, and where to spend your money is crucial towards effective budgeting.
It typically helps if you were taught at a very young age that knowing your needs from your wants and spending on them accordingly are the building blocks of properly managing your finances and budget.
Unfortunately, this knowledge is not so common to some people, and so education in this area is important. What’s the difference between necessity and discretionary expenses? Let’s get educated!
Your needs are your necessity expenses and your wants are your discretionary expenses. This may sound simple enough but, in reality, not quite. Let us expound by providing examples.
A classic scenario is when a new smartphone model of what you currently own is due for a release the next week. Your paycheck is coming up and you think you’re going to buy it to take advantage of the new features even though your current smartphone is just a year old and still works perfectly fine.
Now, are you really addressing a necessity expense or is it a discretionary expense? You just want this new smartphone because it gives you immediate gratification, you don’t really need it. It’s an impulse buy, if you would.
This is not good on your budget.
The same thing can be said when someone purchases an item just because it’s on sale. Buying a sparkling new dress just because it’s discounted by 50% is not actual savings but money spent on something unnecessary, thus a discretionary expense.
Now, what is considered necessity expenses? Necessity expenses are basically your costs of living. These mostly refer to the things you need to spend your money on in order to live day-to-day.
These are your expenses for food, shelter, clothing, healthcare, and so on. This should also include your tax payments, security, gas, and utility bills. It’s the things you buy in order to live a relatively comfortable life.
There are definitely some disagreements when it comes to what a need or a want is. Thus, some find it hard to differentiate a necessity expense from a discretionary expense, resulting in poor budget management.
The reality is that what’s necessary for you may not be necessary for someone else. There’s an expensive computer but you need its capabilities for work. Food takeout is more expensive than cooking your own food but you don’t have the time to do the latter.
So, how do you decide which things to consider a necessity expense and which to consider a discretionary expense in the hopes of managing your finances better?
Knowing the difference is key for proper budget allocation for efficient spending.
Here’s a common budgeting plan:
- List down what you truly earn on a regular basis (salary + side-income if any).
- List down your necessity expenses.
- Choose a budgeting plan.
- Stick to the plan no matter what.
The first key to effective budgeting is to know how much money you truly earn. Add back to your net income amount the expenses that are usually automatically deducted from it, like savings and health insurance. Take tax payments into consideration, too.
Then, implement a common budgeting formula into your plan. Follow the 50/30/20 rule and stick with it by tracking your progress regularly.
That will be 50% for your needs, like the expenses we mentioned above, 30% for your wants or your discretionary expenses (you may treat yourself once in a while), and 20% for savings or debt payments.
The key here is to live with a doable budgeting plan and this formula caters to just that.
Sometimes, we can do all the right things but are still unable to sustain or reach our financial goals. These are the times that you’ll need additional or outside help.
Wealtheo™ has a wealth of financial and budgeting courses to share. You can take advantage of them now! Be on top of your finances. Learn how to budget like a pro and have peace of mind that your money is spent the right way.