If you’ve read the book, “All Your Worth” by Elizabeth Warren, you’ve probably seen her “Balanced Money Formula.” You may have seen it even if you haven’t read the book because it has become the budget of choice for many media pundits and writers. For reference, the formula is as follows:
Needs = 50% of your income
Wants = 30% of your income
Savings = 20% of your income
The formula is designed to be a simple budgeting tool for those who don’t want to take the time to figure out individual budget categories, or who lack a sophisticated understanding of money and budgeting. All you have to do is keep three categories in mind and adhere to those percentages. It’s also supposed to be a budget that allows you to have some fun today, while still providing for the future. But I wonder if it doesn’t really allow people to have too much fun today at the risk of their futures.
While I think the fifty percent allocated to needs is okay, I think that allocating twenty percent to savings and thirty percent to wants needs to be reversed. Even then, it might not be enough and the needs category might need to be dropped down to forty percent. This is particularly true the older you are and the less you have saved. I’ve often thought that people aren’t saving enough for retirement, particularly as the population ages, pensions die off, and Social Security becomes less and less of a sure thing.
This week, the New York Times ran a great opinion piece on the coming retirement crisis. Basically, three quarters of Americans have less than $30,000 saved for retirement. There’s a huge discrepancy between what people have and what they will need. The author points out that since most people are now responsible for their own retirement funds, most of us need to be saving a lot more than we are. Most people will need at least a million dollars to retire comfortably and many will need more.
The looming monster is health care and even a million bucks might not protect your assets from that. Even if Social Security is around, it won’t be enough to bridge the gap and a lot of people are going to be living at or near poverty level in their retirements. The author points out that the only way many people are going to avoid this is to die early, but that’s not an ideal situation.
Part of the problem with the “Balanced Money Formula” is that is doesn’t do enough to address this discrepancy. Saving twenty percent of your income isn’t likely to be enough to cover both your retirement needs and your needs for emergencies and planned expenses like replacement appliances, home down payments, and your kids’ education. On a $50,000 income, that means you’d be saving $10,000 per year (assuming for simplicity’s sake that all of those savings were pre-tax, which they would not be as emergency funds should not be constructed from tax deferred accounts). Twenty-five thousand would go toward your needs and $15,000 would go toward your wants.
Saving $10,000 per year sounds great, but when you spread it out amongst retirement savings, emergency funds, planned replacement expenses and eduction, it isn’t really that much. And, like I said, the number would be lower because much of that would be post-tax money. Perhaps if you began this formula when you were twenty-two and fresh out of college it might work. But if you’re forty and trying to save for retirement, it’s never going to be enough. This means that you need to edge closer to that thirty percent. Ideally you’d go even higher. The problem is that most of us aren’t wired this way. The NYT piece points out that many of us prefer to live for today rather than save for the future. That plus the fact that we always think, “later” is further away than it really is makes saving for our futures a dicey prospect.
In this new era where most people are not going to receive a pension (and even if you think you are, don’t bet on it because more and more go bankrupt every day) savings rates need to go even higher. It’s not unreasonable to expect people to save nearly fifty percent of their income. Yes, this means that a lot of wants are going to have to be scaled way back. You’re not going to live in that big house or drive that $40,000 car. Even things like cable TV and cell phones will have to be cut way back or out entirely. We’ve built a two headed monster in our society: We’ve made people responsible for their own retirement savings, but yet we’ve created a consumer culture that says you need this, that, and the other thing to be happy. The two ideas cannot coexist.
The Balanced Money Formula assumes that they can and I think it’s wrong. It assumes that you can spend 30% of your income on stuff that you want today, while only putting 20% away for tomorrow. This isn’t really a sustainable model, particularly for people who are starting to save at an older age or who already have crushing debt loads. Many people need to find a way to trim their needs category back to about 40% of their income, save at least 40% and spend the remaining 20% on wants. Ideally you’d cut your wants even further and save even more.
I know this isn’t a popular idea. The idea of living less for today while saving for a future that may not happen if you die young isn’t a fun prospect. But I look at it this way. If I spend today and I live to an old age, old age is going to suck. Yes, I’ll have had a great youth, but I really don’t want to be in poverty when I’m old. If I’m unfortunate enough to die young, I’m not going to have too many regrets in my life because I haven’t based my happiness around monetary things. I know a vacation will be fun, but that it’s not worth going into debt for because fun can be had for free. I know that a car is just transportation and thus my happiness isn’t tied to an expensive car. And so on. My happiness is tied to my family, my relationships, and doing things to leave this world a little better than I found it.
On the whole I’d much rather have a secure future than a fun (read: expensive) youth. By saving as much as I can now, I can ensure that both stages of my life are comfortable and filled with contentment. Saving fifty percent of an income isn’t impossible, but if you can’t do that, don’t aim as low as twenty percent. Aim for thirty or forty percent. Then you might find that both phases of your life are better balanced and that you can face both phases knowing that you will be okay.
(Photo courtesy of winnifredxoxo)