I love money. I love everything about it. I bought some pretty good stuff. Got me a $300 pair of socks. Got a fur sink. An electric dog polisher. A gasoline powered turtleneck sweater. And, of course, I bought some dumb stuff, too. -Steve Martin
Everyone always likes talking about money. There is an old saying about how money makes the world go round. Everyone has their ideas about money, and how it should best be used. When you think about it, there are only about five ways to use money!
At least, that’s what I recently told someone with extra money. This person had extra dollars and wanted to know how to best use them. Since I am not their financial planner, I couldn’t give this person specific advice, but I was able to provide information on the five general uses of money.
The following uses of money are listed in what I feel is the order of highest importance to least importance:
Spend Money
The first use of money is to “Spend” it on needs, wants, or life enhancers.
*Needs– Everyone spends money to satisfy the needs of basic living. Everyone has to eat and needs clothes, housing, and a means of transportation. These are the things that Jim Saulnier, CFP calls his Minimum Dignity Floor (food, transportation, shelter, utilities, and health care.) For most consumers, these basic needs of living are a necessity of life and consume the vast majority of income. (Retiring With Enough Podcast: AN INTERVIEW WITH JIM SAULNIER, CFP.)
*Life enhancers– Money can also be spent to make life more pleasurable. These expenditures are for things that are not necessary, but make life easier and better. Some examples of life enhancers would include flying first class, having someone clean your house, having someone cut your grass or wash your car, having a gym membership, or monitoring college classes. Anything that is not a basic need and would make life better or easier would be classified as a life enhancement.
*Wants– Money can also be spent on things that are wanted, but not needed. Someone may want a luxury car but only need basic transportation. Someone may want designer clothing, or extravagant jewelry when these things are not necessary. Many homeowners want a swimming pool, a covered cabana, or an outdoor kitchen. These would also be considered wants, and not needs. Anything that is not necessary for basic living and does not enhance our lives, but is something that we want would be considered here.
Store of Value
The second use of money is as a Store of Value. This is money that is saved and reserved for some future use. Money saved can be used to create an emergency fund, saving for special projects, or creating liquid assets. The money that is saved within this group is usually placed in short-term liquid assets.
*Emergency fund– One of the basic uses of saved money is to create an emergency fund (a pool of money dedicated to emergency needs.) This emergency fund amount can range from a minimum of $500 to six months or more of personal income. (See: PREPARING FOR THE UNEXPECTED: THE IMPORTANCE OF AN EMERGENCY FUND.) The concept is to create a pool of money that will not be used to pay for basic expenses, is liquid, and is available for emergency use.
*Special projects (house fund, Christmas fund, furniture fund, etc.)– some readers may be old enough to remember when banks provided Christmas Club accounts. This account was dedicated to saving money for Christmas expense payments. The same type of thought process can be used to dedicate money in a special account to save for a down payment on a house, Furniture needs, educational needs, or future wedding expenses. Any extraordinary expense can be accounted for and saved for in a special account.
*liquid assets– Money that is saved in accounts that provide easy access to funds are termed liquid assets. These accounts are funded with dollars that are not needed for basic expenses but are available if any extraordinary expense (that cannot be funded in an emergency fund) should arise. Usually, liquid assets are kept in short-term savings accounts in banks or money market accounts.
Invested Money
The third use of money is to Invest for long-term appreciation. The three main types of investments are tax-deferred accounts, tax-free accounts, and after-tax accounts.
*Tax deferred– Workplace retirement plans(such as 401(k), 403B, pension plans) and IRAs. Any type of account where taxes are exempted until the funds are accessed. Certain Annuity types can also be included in this category.
*Tax-free– These accounts are also commonly called After Tax accounts. The benefit of investing in tax-free accounts is that both contributions and earnings grow tax-free. Roth IRA accounts are included in this group.
*After tax– These accounts are commonly called brokerage accounts. Investments in these accounts usually consist of money that has already been taxed. The benefit of investing in these accounts is that only earnings are taxed.
Money Used to Pay Debts
The fourth use of money is money used to Reduce or Pay Debt–
*Credit card debt– Also called Consumer debt. These are usually short-term debt obligations. Many financial planners recommend paying off these short-term debt obligations first.
*Home mortgage– A home mortgage is considered long-term debt. Accelerating mortgage payments can have a profound effect on the ultimate term of the mortgage and the total loan repayment amount. (See: HOME FINANCING UNVEILED: THE ULTIMATE MORTGAGE HANDBOOK.)
*Mortgage on vehicles– Technically, automobile mortgages are considered short-term debt. These non-credit card debts can also include Auto loans, boat loans, motorcycle loans, and other types of short-term debt obligations.
*Other debt– This type of debt would include personal loans received from parents or relatives, gambling debts, and debt incurred from healthcare expenses, or illness.
Charitable Giving
The fifth use of money is in Giving It Away-
*Charitable giving– This type of giving includes charitable contributions to a house of worship or any tax-exempt organization.
*Legacy giving– This type of giving includes money given to children, grandchildren, or other heirs.
*Random Charity– It is also possible to engage in random acts of giving where money is donated to different organizations or individuals in need.
In the final analysis, almost every function of money can be included in one of these five general headings.
Final Thoughts
Money is said to be fungible. Does that mean that it’s fun to spend? Not quite!
According to Investopedia: Fungibility is the ability of a good or asset to be readily interchanged for another of like kind. Goods and assets such as cars and houses that aren’t interchangeable are non-fungible. Money is a prime example of a fungible asset because a $1 bill is easily convertible into four quarters or 10 dimes.
But fungibility does mean that dollars that you earn can be exchanged for goods, or services or can be used in any of the five ways described above.
I have always been a saver. My wife comes from a very conservative background, so she and I are very compatible in this regard. For us, this seems to be a pretty cut-and-dry case for saving and investing, but problems can occur in couples where one person in the couple is a spender, and the other person is a saver (See: EMBRACING THE PRESENT: CHOOSING TO LIVE NOW.)
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