Current Needs versus Future Needs

Current Needs versus Future Needs

By: Eric Johnson

When developing a financial plan, you face a trade-off with your disposable income each pay period. Disposable income is the income that remains after deducting payroll taxes and other mandatory payments each pay cycle. Our disposable income faces a unique trade-off: how much money to spend today versus how much to save for tomorrow. On the surface, that is a simple proposition. “Of course, we should save as much money as possible for tomorrow!” It is a more challenging decision than we will admit on the subsurface.

This trade-off depends on two factors: current needs and future needs. Let’s start with everyday needs. Your current spending level largely depends on the necessities of life and your average propensity to consume. Economists define the average propensity to consume as the proportion of annual income spent on consumption. All of us must purchase necessities. If you do not believe me, try going a month without food, utilities, medicine, or clothing. Very quickly, you will realize necessities are goods we must purchase. Our income levels will determine our budget’s spending percentages on necessities and luxury goods. Individuals with low or modest incomes have more significant consumption propensities than wealthier individuals. This reality is because low-income consumers spend more of their budgets on necessities than more affluent consumers. Thus, as your income increases, necessities become a smaller portion of your budget, and you can devote more money towards savings or luxury goods.

However, two individuals on different spectrums of the income scale can have a similar average propensity to consume. Wealthier people may feel purchasing more luxury goods or higher-quality necessities is necessary. A poorer person may face budget constraints that cause them to have a more significant average propensity to consume because essentials make up a considerable portion of their budget. While an increase in wealth theoretically decreases an individual’s propensity to consume, it does not always happen.

Now, let’s shift gears and talk about future needs. Future needs will vary for all of us. At a basic level, though, examples of future needs we are all likely to experience include:

• Retirement
• Child’s education
• Savings for a dream vacation
• A rainy-day fund for a new car or significant homeowner repair

As you can see, a comprehensive list of future needs can quickly evolve into many topics. What is essential to understand is that every dollar we spend today on goods and services is one less dollar available in the future for our retirement nest egg, car repairs, or dream vacation. While maintaining a high standard of living today makes us happy, it will only deprive our future selves when we try to replicate our standard of living in retirement. Therefore, a carefully crafted financial plan sets aside some of our disposable income today and places it in investment vehicles that generate income, such as interest. Alternatively, some investment vehicles allow you to build your savings through savings and an increase in the asset’s valuation. Generating a return on your savings helps you grow your nest egg and combats the effects of inflation. Remember the critical rule of finance: a dollar today is worth more than tomorrow. Inflation erodes your dollar’s future worth. Your rate of return on your savings helps you ward off the impact of inflation and maintains your current standard of living when your income level falls.

Recognizing your current and future needs will help you develop healthy spending habits. While it is tempting to splurge each pay period, it is essential to remember that every dollar you spend today is one less dollar you have available in the future. Occasionally, splurging is an excellent way to reward yourself for hard work or accomplishments. However, do not let splurging on luxury items outside your means become a daily facet of life. Avoiding the temptation of overindulging on your current needs will help you direct some of your disposable income to savings or retirement accounts. Review your budget to determine your necessities in the coming month. Then, eliminate some of the luxury goods you prefer to indulge in each month but could go without occasionally. You will soon discover you have more disposable income than you realize. Redirect those cost savings to your investment vehicles as often as possible. Over time, you will build a sizeable savings account that can weather future predicaments that life may toss.

Mr. Johnson is the Director of Financial Aid and an adjunct faculty member at Goldey-Beacom College.