Before she was a US senator and 2020 presidential candidate, Elizabeth Warren was a professor at Harvard who also happened to write a couple of really good books on personal finance and economic instability in the U.S.
In fact, her first book, The Two Income Trap, (co-written with her daughter, Amelia Warren Tyagi) highlighted many of the economic issues we’re still dealing with today, like rising housing and educational costs, stagnant wages, the hollowing out of the middle class, etc., long before they were daily fodder in the biggest newspapers in the country.
She and her daughter also lay out some policy changes that could help alleviate financial stress on middle class families, including some that she’s since introduced during her presidential run.
That one’s worth reading, but I really want to talk about her other book, All Your Worth, also co-written with her daughter. It’s a fairly straight-forward personal finance book in many ways, but what’s so special about it is that it’s this book that pioneered the “50/30/20" budgeting system you see promoted by many financial experts these days. (Lifehacker commenter Antifaz originally brought this book to my attention, so thank you for that!)
In All Your Worth, Warren and Tyagi write that the key to managing your finances isn’t cutting out a coffee here and there, or only shopping the sale section, but rather it’s balance. This isn’t new now — in fact, I write about it a lot — but when their book came out in 2005, there wasn’t the wealth of quality financial information readily available like there is today. They write:
A lot of budgeting starts at the edges and works in “cut back here” and “trim over there.” That’s a little like planning a diet by saying “cut out cookies” and “no sugar in your coffee.” This approach may (or may not) work for slight modifications, but it is not a comprehensive lifetime plan. And if you don’t have a master plan, then trimming a few expenses in one place while you overspend elsewhere won’t do you any more good than cutting out doughnuts while you gorge on cupcakes.
We start by approaching money in a whole new way. No complicated lists. No spending diaries. Instead, we will help you analyse your spending by dividing it into three simple categories. There is one category for your regular monthly bills, a second category for the money you spend “just for fun,” and a third category for savings.
Those three categories make up the 50/30/20 budget: 50 per cent of your money goes toward needs, or Must Haves (housing, transportation, food, bills), 30 per cent goes to discretionary spending or Wants, and 20 per cent goes to Savings.
As they write, this plan works because it’s a lifetime plan; there’s no get rich quick scheme here. Instead, over time, you try the best you can to stick to those categories so you’re always in a fairly comfortable spot. Obviously, it’s possible (and necessary in some circumstances) to deviate from the formula, but it’s meant to work for most people.
Redefining “Must Haves” and “Wants”
One of the keys to this framework is how Warren and Tyagi define needs and wants. As they write, the “rules of the game” have changed over the past one or two generations (and that point is driven home well in The Two Income Trap.) As things are now, they say:
You can get a mortgage that’s too big for you—and the banks will help you do it. You can get a car lease that chews up half your income. You can wind up with a student loan bigger than some home mortgages. And as sure as the sky as blue, you can rack up credit card debt without blinking an eye, even if you don’t have 50 cents ($0.70) to make payments.
That doesn’t mean striking the right money balance is impossible; it just means you need to be aware of the rules—and doubly aware that the bank, your credit card company, your student loan servicer, etc., aren’t there to help you.
And, as they write, “if you aren’t saving enough it is because you are spending too much on your Wants or your Must Haves (or both).” And there’s comfort in that, because once you’re able to strike the proper balance with your Wants and Must Haves, “you will start saving automatically.”
But striking 50 per cent for Must Haves is likely where most people roll their eyes and check out. Only 50 per cent of your paycheck on rent, transportation, food, insurance, etc.? In this economy? But as Warren and Tyagi write, it is possible to hit that number. Must Haves are your “hardcore commitments,” things you have to pay no matter what.
Suppose you get laid off. That’s no fun to think about, but we all know it could happen. If your Must-Haves take only 50 per cent of your income, then how would you fare? A lot better than you might think. With Must-Haves at 50 per cent, your unemployment check could cover your needs for several months. (In most states, unemployment insurance covers roughly 50 per cent of your previous salary, up to certain limits.) ... Likewise, if you were in a serious accident and you couldn’t work, most disability policies would cover about half of your salary, and so your basic needs would be met. And if you are married, keeping your Must-Haves at 50 per cent means that you could get by on only one paycheck for a while.
Keeping your Must-Haves at 50 per cent of your income gives you flexibility, which gives you some power and control. If your needs only require 50 per cent of your income, then you can easily cut back other spending in an emergency.
Your Wants, on the other hand, can be pretty much anything you, well, want, as long as you keep them to 30 per cent of your spending. That includes things like cable, Netflix, haircuts, dinners out, concerts, birthday/Christmas presents, etc. “A spending cap can sound so dreary, full of denial and no-no-no,” they write. “But this cap is all about liberation, not deprivation.” You can enjoy your money more when you know all of your bases are covered.
And, like getting your Must-Haves under control, it gives you more freedom and flexibility.
“Setting aside a specific amount for your Wants is the key to breaking the cycle of crash-diet budgeting,” they write. “It puts an end to those fits of good intentions when you suddenly declare you Must Clamp Down On All Extra Spending Immediately.” That’s what’s really dreary.
Over on Twitter, some people are roasting MarketWatch for an article originally published in January that says you should have double your salary saved by the time you're 35.
The book walks you through how to strike your balance, how to meet most of your other money goals and traps that you might fall into. One “trap” I wanted to highlight, which I see a lot in my own interviews/talks with friends/etc. is the “all-or-nothing” approach to money and investing. They write,
I’ll never stick to a budget.
My credit is ruined, so why bother?
I always carry a balance on my credit card.
Never. Always. Forever. These are the hallmarks of all-or-nothing thinking.
All or nothing thoughts add up to one thing: If I can’t be perfect, there’s no point in trying to be better. One little mistake, one little stumble, and it’s all over but the weeping. Quit at the first misstep. Sound familiar?
Over the years, we have seen the concept of financial balance provoke an attack of all-or-nothing fatalism in otherwise reasonable people. “I’ll never cover my Must-Haves on half my income! I can’t save $US2 ($3), let alone 20%!”
Maybe you feel the same way. Maybe you looked at that 50-30-20 formula, and you wanted to throw this book against a wall and shout, “I can’t do that!”
...[But] think of it this way: If you can change even a . 60-40-0 budget to a 55-30-15 plan, you will be much better off. Granted, you won’t be perfect. But you will start getting ahead, each and every month. Moreover, with those numbers, in a few years you will be in a better place than the overwhelming majority of Americans. And that will be something to be proud of.
That’s why I emphasise the need to start small and build. Yes, if you’re not saving or investing already, you’re not likely to hit your goal over night. That’s impossible. But it doesn’t have to be all or nothing—if there’s anything money/compounding shows us, it’s that small changes can equal big results. Again, we’re not playing the short game here.
There’s a lot more in the book, including worksheets and exercises, so if you’re interested in a basic-level PeFi book, I recommend it (and The Index Card by Helaine Olen and Harold Pollack, which has a similar vibe). Can’t wait to see what other nerdy financial proposals Warren brings to the table this election season.