Create a New Financial Plan for the New Year, Part 1

Ivanna Hampton: Welcome to a special episode of Investing Insights. I’m your host, Ivanna Hampton. The start of a new year marks the time of likely wanting to improve your financial health. You may promise to spend less, save more, and manage your money better. Now old financial habits tend to make those New Year’s resolutions challenging to keep, but don’t give up. Morningstar Inc.’s director of financial psychology, Sarah Newcomb, has written about money management, and she says a change in mindset can help you develop a financial plan. Here’s part one of our conversation.

Hi Sarah.

Sarah Newcomb: Hi.

Hampton: So, financial advice tends to tell people to break down their budgets, needs versus wants. What are your thoughts on this concept?

Newcomb: Yes, I hate this concept. I know you know that. I mean, there’s nothing really wrong with the needs versus wants in one sense, but what it does is it actually runs counter to the way that our human motivation runs. So just to put some context on it: When we say this—you have to know the difference between a need and a want—it’s well meaning. What we’re trying to say is you need to prioritize your spending, right, and understand that some things are necessary, some things are not. The problem is that: Think about Maslow’s hierarchy of needs. On that hierarchy, down at the bottom we’ve got our physical needs, then our physiological needs, and then our emotional and social and needs for meaning and purpose.

And the thing that the needs versus wants paradigm does is it basically says is if it’s not down at the bottom of Maslow’s hierarchy, it’s a want. But if you actually go and read Maslow’s work, he was very clear that the hierarchy idea is not an order of importance. It’s an order of primacy. If you had no needs met at all, you would want those physical needs met first, but as soon as your needs are met to some extent, your higher-order needs become apparent to you. So it’s not Maslow’s hierarchy of wants. It’s Maslow’s hierarchy of needs. So I think of them as all five of these categories, all the way up to self-actualization and meaning, are things that humans need to feel like we’re thriving. And so if we budget from a needs versus wants paradigm, what we’re saying is I’m going to make a plan to feel deprived, emotionally, socially purpose wise. And no wonder we hate it. So I think we need to switch our thinking a little bit to make budgeting align more with the way that our psyches work so that we won’t be unconsciously fighting against it all the time.

Hampton: What should we include in our needs?

Newcomb: Well, everything on Maslow’s hierarchy is a need, so your social life is a need. Love and belonging is a need. Status is a need. We need respect from others. Meaning, spirituality—these things are needs. So the question then becomes, it’s just a simple shift of wording, but it represents a big shift in how you’re thinking about your priorities. I recommend thinking in terms of needs—which are all on Maslow’s hierarchy; you can find them all there—and strategies for meeting needs. Everybody has the same needs. Humans all over the world. They’re universal to all of us. We all have the same needs, but our strategies for getting our needs met—that’s where we can be creative and flexible. So you’re not learning the difference between a need and a want and just discounting and cutting out whole areas of spending that may be meeting very important deep needs for you, but you are finding ways to get all of your needs met within the constraints of your budget.

Hampton: You’ve written that our wants point to our needs. Can you explain that?

Newcomb: Let’s talk about wanting to go out with friends, right? I want to go out and have a drink and socialize with my friends. Well, what’s the need? Obviously the need isn’t a cocktail, you know? The need is that connection. And that sense of maybe fun or adventure, right? So when you pinpoint the need then you’re able to find another strategy that will meet the same need for less money. So, in that case you could say, well, my need is to socialize, so I don’t necessarily need to get the most expensive thing on the menu. I definitely don’t need to buy a round of drinks. Maybe I just get one drink and an extra cup of ice and do something where you’re spending less money but you’re still meeting your need. Or you’ll have people over. You find ways to be creative in keeping within the confines of your financial constraints, but you’re not constraining your ability to feel fulfilled.

Hampton: How do we take that example of buying drinks, maybe you get the less expensive drink, and apply it to a budget for running a household.

Newcomb: Some of the biggest things with running a household budget: Most of us that struggle with this are spenders, and I know this from personal experience, as someone who’s always been a spender. The spending that we do—a lot of times we’re trying to meet our emotional needs with spending. It takes some honesty and some self-reflection. The way that I do it is you look at your budget and rather than just crossing things off and saying well, I can’t afford that because I don’t need it to survive. You first asked yourself what are the needs that I’m meeting with this right now. For example, maybe you don’t care that much about going out to eat, but you have a restaurant budget. You have a line item in your restaurant budget, but it’s not that much of a priority for you. But on the other hand, maybe your need for self-expression, you get that met through fashion, through shopping for clothes. So you could then balance your budget in a way that you put more toward the things that really meet your needs and less toward the things that you don’t care so much about.

Or if you find that there are places where you really need to cut back, then you need to find strategies that simply don’t cost as much that also still meet the need. One big concept that I think is useful here is understanding that, in general, spenders are meeting needs for freedom, autonomy, self-expression, fun, enjoying life today. Savers, on the other hand, tend to be meeting needs for security, safety, and a sense of those security needs. And so you can understand why if you have a couple where one is a spender and one is a saver, they would clash. Because when you say “Don’t spend that money,” what you’re saying is “Don’t feel free. Don’t express yourself. Don’t enjoy your life.” Or when you say “You can’t save that money,” what you’re saying is, “I don’t care about your need to feel safe.” So you can understand why these things would create deep conflict. But once you understand that everybody’s got the need to feel safe as well as the need to express themselves, then you can start to say now how can we come up with solutions where we can meet the need to feel safe as well as the need for fun and entertainment or whatever else is getting met over here. And then you’re on the same team and you’re creative problem-solving together rather than just arguing over strategies.

Hampton: It seems like to start this off you need to ask yourself whether I’m a spender or a saver.

Newcomb: I think most people would know where they’re on on that spectrum, right? And if you are a spender, if you’re in a relationship where your significant other is the opposite, you probably know that. But I think that thinking in this way offers us a language to talk about, even when you’re talking to yourself about money, what needs are you really meeting with that spending? It’s the same thing when you’re talking with someone else: What needs are they trying to meet? And then you get to conversations that go a lot deeper and they get to the root of what’s really going on, so it is actually an opportunity to grow closer.

Hampton: If we take these strategies, but we find out like I love to spend, right? I have that urge to splurge. How can you use these strategies to fight that urge?

Newcomb: You will start to recognize—I mean, part of this, what Jung said was “until we make the unconscious conscious, it will rule our lives and we will call it fate.” And I love that because the process here is first self-reflection, and then you will start to notice, you’ll just notice what’s happening, and then you have a choice. Once you notice what’s happening, you have a choice how you respond. You may not change your behavior right away, but you’ll start to notice. How do I feel when I’m getting that urge to splurge? For me, it’s boredom or depression. Those are the two things that really drive that urge to splurge. So I have learned over time that when I’m thinking about going out just to shop, I will ask myself, What do I really need? What is going on? And usually a little bit of self-reflection and a walk out in the sunshine or hanging out with my dogs can keep me from spending, and it may seem very simple but it does take some practice. It takes some practice to recognize what your particular triggers are and then to catch yourself, and then once you catch yourself to start to have alternative things already in your mind, different strategies already in your mind. When you’re in the moment, that’s not the time to be thinking of new strategies. We’re not good at that. So in a time of reflection, you can come up with new ways the next time you feel that urge to splurge. What’s something you could do to meet the need? And then when you’re presented in the moment with the choice, you’ll have an alternate in mind already. It just gives you a leg up when you’re in the heat of the moment.

Hampton: What would you recommend for someone who’s new to this to put together for their moment of reflection?

Newcomb: A little note card is helpful. What I would say is: If you’re someone that struggles with spending, you are not alone, first of all, think about the last time you kicked yourself for spending money. The last time you regretted it and ask yourself, “OK, what were the needs that you were trying to meet? Because you were trying to meet a legitimate human need. And I think we kick ourselves and we add shame to the situation, which is not helpful. So rather than being ashamed of spending too much yet again, ask yourself what were the needs you were trying to meet? And then what were the needs that you threatened or didn’t meet through the strategy of buying the thing? And then just think in that situation, what is something you could have done instead that maybe would have met all of your needs better. And so by reflecting on a past situation we can set ourselves up for success in the future.

Hampton: Very good advice. So now we know the emotion. We have our note card. Are we ready for that urge when it comes?

Newcomb: Sometimes. I mean, it really depends. Behavior change is a long process, and I think it’s something that we have to be patient with ourselves about. Like I said, you will be more likely to notice what’s happening, psychologically, once you’ve done this self-reflection. And once you notice it, then you have the opportunity to make a different choice. It doesn’t mean that you will every time, but over time if you persevere, you will and it’s actually very empowering when you finally do.

Hampton: Thank you, thank you. I know there are people out there listening. They’re wondering, “OK, the next time I’m driving by my favorite big-box retailer, do I turn into the parking lot? Do I keep going?” So that’s good advice. Think about the note card.

That was part one of Create a New Financial Plan for the New Year. We’ll bring you Part 2 next week, where we’ll focus on how to avoid fighting about money. Thanks to Sarah for explaining how to rethink budgeting and avoiding the urge to splurge. I’m thanking podcast producer Jake Vankersen for his hard work. And thanks to all of you for tuning in to Investing Insights. Be sure to subscribe to Morningstar’s YouTube channel for videos about personal finance, investment ideas, and market news. I’m your host, Ivanna Hampton. I’m a senior multimedia editor here at Morningstar. Take care.

Read about topics from this episode.

Hate Budgeting? Try Rethinking It.

Got the Urge to Splurge? 4 Steps to Overcome Your Overspending Habit

How to Avoid Arguing Over Money