Books and articles about living on a personal budget often emphasize the importance of cutting spending on luxuries. They say that by cutting out “frivolous” expenses, such as coffeehouse lattes or cable TV, you can save thousands of dollars each year. Financial writer David Bach has dubbed this concept “the latte factor.”
It’s pretty clear that the items listed above really are luxuries, while expenses like rent and utility bills are necessities. However, in other cases, the line between luxuries and necessities isn’t so clear.
For example, is a daily newspaper a necessity because you need to stay informed, or is it a luxury because you can read the news online for free? Is a cell phone plan a luxury because you already have a landline, or is it a necessity because you need to keep in touch with your work contacts at all times?
As it turns out, the answer to these questions isn’t absolutely clear-cut. Economists, pollsters, and business owners have different ways of drawing the line between luxuries and necessities – and that line can actually move over time.
The dictionary defines a necessity as “an indispensable thing” – something that everyone needs. There are some things that everyone clearly needs just to survive, such as food, water, shelter, and clothing.
Yet even within those categories, there’s a surprising amount of wiggle room. For instance, you need food to live, but that doesn’t mean you need a gourmet meal at a four-star restaurant. You need shoes to protect your feet, but that doesn’t mean you need a $400 pair of Italian leather boots.
Various social scientists have attempted to come up with some clearer rules about what exactly is a necessity. However, the guidelines they’ve come up with aren’t all identical. And, as at least one source shows, the way ordinary Americans draw the line between necessities and luxuries can change as society changes.
Basic Needs: The Gallup Basic Access Index
Over the past decade, Gallup polls have tracked Americans’ access to “basic necessities,” such as food, shelter, clean water, and healthcare. Gallup’s list of basic necessities includes 13 items, which can be grouped into three broad categories:
- Food. Gallup asks respondents not just whether they can afford food for themselves and their families, but also whether it’s easy for them to find affordable fresh fruits and vegetables in the city or area where they live. It also asks whether their neighborhood provides access to clean and safe drinking water.
- Housing. The most basic question in this category is whether respondents can afford “adequate shelter or housing” for themselves and their families. However, Gallup also treats a safe and healthy neighborhood as a necessity. It asks respondents whether they’re generally satisfied with where they live, whether they feel safe walking alone at night, and whether they believe that their area is “getting better.”
- Health. Nearly half of Gallup’s 13 questions fall into this category. They ask respondents whether they have a personal doctor and make yearly visits to a dentist. Then, since receiving healthcare isn’t the same as being able to pay for it, they ask whether respondents have health insurance coverage and whether they can afford to pay for their medical expenses and healthcare. Finally, they ask respondents whether the city or area they live in provides them with a safe place to exercise and easy access to medicine.
In a 2012 poll, more than 80% of Americans said yes to all these questions. However, that still leaves nearly one in five Americans managing to survive without at least one of these “basic necessities.” This shows that even the 13 items Gallup treats as bare-bones necessities aren’t things people literally can’t live without – they’re just things no one should have to live without.
Must-Haves: The Warren-Tyagi Formula
In 2006, law professor Elizabeth Warren – who has since become a U.S. senator – published “All Your Worth: The Ultimate Lifetime Money Plan” with her daughter, economist Amelia Warren Tyagi. One of the key concepts in this book was the “Balanced Money Formula,” which divided all spending into three categories: Must-Haves, Wants, and Savings. To keep your spending in balance, the book argued, you should spend no more than 50% of your income on Must-Haves and no more than 30% on Wants, while putting at least 20% into Savings.
Warren and Tyagi define “Must-Haves” as bills you “have to pay no matter what” – expenses that you can’t eliminate no matter how low your income is. All the basics, like rent, transportation, insurance, and utilities, go into this category. By contrast, the “Wants” category includes “all the treats and extras,” such as clothes, movies, and restaurant meals.
The Warren-Tyagi formula approaches needs rather differently from the Gallup poll. For instance, both definitions classify housing as a necessity, but for Gallup, meeting your need for housing simply means having “adequate shelter” in a safe neighborhood. For Warren and Tyagi, by contrast, your housing “Must Have” is enough money to cover your rent or mortgage, no matter how large it is.
Similarly, your “Must Have” list could include a car payment and auto insurance, even though a car isn’t one of the basic needs on the Gallup list. Even if a car isn’t a necessity for you, once you’ve bought one, paying the bills for it becomes a necessity for you – an expense you can’t do away with, except by resorting to the extreme measure of selling the car. In other words, your “Must Haves” aren’t the bare necessities of all human life – they’re the specific necessities of your life, as you’re living it right now.
This means that, unlike Gallup’s list of basic necessities, your “Must Have” list can change. In fact, Warren and Tyagi emphasize that living on a budget often requires you to cut spending on Must Haves, as well as Wants. Paying your rent or mortgage is a necessity, but if you’re spending more than half your income on the mortgage for a new house that’s too big for you, that’s a necessity you can’t afford. Downsizing to a smaller house or an apartment is a way to get your budget back in balance while still meeting your basic need for housing.
Changing Definitions: The Pew Survey
The list of life’s necessities doesn’t just change over time for individuals – it can change for the population as a whole as well. For several years, the Pew Research Center has periodically asked Americans which items they consider necessities vs. luxuries. The table below shows how the responses from the latest poll in 2009 have changed since the 2006 poll, and how those results differ from a 1996 poll by a different organization that asked the same questions.
|Item||Percentage of Americans calling it a necessity|
|Landline Phone||68%||not asked||not asked|
|Clothes Washer||not asked||90%||86%|
|Home Air Conditioning||54%||70%||51%|
|Cell Phone||49%||49%||not asked|
|High-Speed Internet||31%||29%||not asked|
|Cable or Satellite TV||23%||33%||17%|
|Flat-Screen TV||8%||5%||not asked|
To a large extent, the changes in the numbers over time reflect changes in technology. For instance, no one considered a flat-screen TV or an iPod a necessity in 1996, because they didn’t exist.
Advancing technology can also make some older technologies less important. For example, the widespread availability of streaming media made cable TV less important, while high-speed Internet has become more important. Pew notes that, in general, “old tech” appliances (such as clothes dryers, home air conditioners, and dishwashers) are the most likely to have dropped in the polls over time, while new technologies like cell phones and high-speed Internet have either risen or stayed the same.
More generally, these changes aren’t just about new inventions – they’re about new standards in society. It’s easy to get along without a cell phone when no one you know has one, but when all your friends are used to texting as their main way of communication, lacking a cell phone can mean falling out of touch. This would explain why 60% of adults under 30 years old described a cell phone as a necessity in the Pew survey, while only 38% of those over 65 did. For that age group in 2009, landline phones were still the standard, and a cell phone was just a nice extra.
This also gives a clue as to why the percentages went down for so many items between 2006 and 2009. When the Great Recession hit in 2007, Americans began paring back their budgets. As more people went without things such as air conditioning or dishwashers, doing so began to seem normal, and people became less inclined to see them as necessities.
In short, what people consider a necessity doesn’t just depend on what’s available – it depends on what’s normal. This fits in with the findings of happiness economists, who have noted that people’s happiness often depends less on how much money they have than on how much they have compared to others. It’s easy to be satisfied with a small house when all your friends live in apartments, but if they all live in large houses, a large house comes to look like the norm – or even a necessity.
If a necessity is something that everybody needs, it seems logical that a luxury must be something that nobody really needs, but many people want. However, the dictionary definition goes a little bit further than this. It says a luxury is “an inessential, desirable item that is expensive or difficult to obtain.”
Note that this definition has two parts. A luxury isn’t just something that’s “desirable” – it also has to be expensive. This suggests that luxuries are valuable not just for the enjoyment they provide, but also as a sign of status.
For example, a fur coat is valuable partly because it’s nice and warm, and an iPod is valuable because you can store all your favorite tunes on it. However, another part of what makes these items desirable is their high price tags. Because not everyone can afford them, owning one is a way to show your wealth and position to the world.
Luxury Goods and Income
If luxury items are, by definition, expensive and unnecessary, then it follows that people must be more likely to buy them when they have plenty of cash. Economists have a name for this concept: “income elasticity of demand.” In layman’s terms, that means how much your income affects your chances of buying certain types of products.
Economics Help explains this concept by comparing three different types of goods:
- Inferior Goods. These are products that people are more likely to buy when their income falls. One example is cheap, single-ply toilet paper, a good way to save money compared to regular, two-ply toilet paper.
- Normal Goods. These are products that people buy all the time – everyday basics like food and clothing. People buy more of these goods when their income is higher, but not all that much more. In general, they buy only what they need, stocking up just a little when they’re flush with cash.
- Luxury Goods. These are products that people are much more likely to buy when their income rises. Two good examples, based on the Pew poll results, are flat-panel TVs and iPods. If you’ve just gotten a raise or received a hefty tax refund, you’re much more likely to go out and buy a new flat-screen than if you’re on a strict budget.
Based on this definition, it’s easy to figure out which items are luxuries as opposed to necessities. Just look at how the demand for them changes when people’s incomes rise. If rising incomes cause a big surge in demand for a certain type of product, that product must be a luxury good.
Luxury Goods and Status
One specific type of luxury good is known as a “Veblen good” – named for the economist Thorstein Veblen, who coined the term “conspicuous consumption.” With normal goods, as price goes up, demand falls – that is, higher prices make people less likely to buy. With Veblen goods, however, just the opposite is true. As prices go up, people become more likely to buy the product, because they assume that a higher price tag means higher quality.
Veblen goods are generally items that people can use to show off their social status, such as original artworks, designer clothes, or luxury cars. They can also be “positional goods” – items that are scarce, which makes competition for them high. An example is tuition at an elite university, such as Princeton or Yale. Spending more money on these goods lets people demonstrate their position in society – and, at the same time, helps them hold onto it.
One way to identify luxury goods, and particularly Veblen goods, is by their labels. Forbes defines luxury brands as those that offer “status and style” in addition to mere functionality. That’s why counterfeit versions of luxury brands are so common: Their makers are hoping to cash in on the cachet of the designer label without having to actually invest in the quality materials and construction of genuine luxury goods.
According to Forbes, the most valuable luxury brands in the world fall into three main categories:
- Clothing. Clothes are one of those items that blur the line between necessity and luxury. Everyone needs to get dressed before leaving the house, but designer clothes provide status that Walmart clothes cannot. The top high-end clothing brands, in terms of the company’s total value, are Ralph Lauren, Prada, and Burberry, each valued at more than $4 billion.
- Leather Goods. Like clothes, shoes are a necessity that a high-status label can turn into a luxury. Many clothing designers also sell shoes and handbags, but some brands are best known specifically for their leather goods. For instance, Gucci is best known for its stylish footwear. Louis Vuitton, which specializes in luggage and handbags, is the world’s single most valuable brand, at approximately $23.58 billion.
- Jewelry. Unlike clothing and footwear, which everyone needs to own in some form, no one actually needs to wear jewelry. That means jewelry of any kind is a luxury item, but some brands carry more status than others. The biggest-name jewelers in the world are Tiffany, Cartier, and Hermès (which also sells high-end leather goods and fragrances).
According to a 2014 paper published in the Journal of Consumer Psychology, people don’t necessarily buy luxury brands because of their snob appeal. In fact, tests showed that people were more likely to feel interested in luxury brands after performing a task that gave them a feeling of accomplishment than after performing a task that made them feel snobbish and superior to others.
However, the same study also found that once people actually own a luxury product, it tends to give them a feeling of snobbish pride, as opposed to the pride that comes from accomplishment. Moreover, the study showed, when people see designer labels, they tend to think of the wearer as snobby rather than accomplished. So, even if people buy luxury goods mainly as a way to reward themselves for their accomplishments, the message they’re most likely to send with these purchases is that they’re just showing off.
The line between necessities and luxuries isn’t rigid. It changes over time as new goods enter the market or become obsolete. It also depends on what’s seen as normal – not just in the world, but in your own social group.
This means what’s a clear luxury for one person could be seen as normal – even necessary – to another. If your friends don’t have cars, a car could be a luxury. If everyone you know has a car, it becomes a necessity. And since part of a luxury’s job is to show status, even a “luxury car” like a Mercedes ceases to be a luxury if everyone you know has one. It’s seen as normal, par for the course – if you want to display your wealth and position, you have to upgrade to a Porsche.
None of this means that spending on luxuries is, in itself, a bad or dumb idea. After all, luxuries aren’t just for showing off – they’re also valuable because they’re high-quality items that look better, feel better, or last longer than ordinary goods. Allowing yourself a few luxuries in your life – as long as you can afford them and you get genuine pleasure out of them – is a way to reward yourself for your hard work.
The important thing is to be able to recognize them as luxuries. Knowing what’s a necessity and what’s a luxury for your personal situation helps you figure out what to cut if you ever have to tighten your belt. And, at the same time, it helps you appreciate the luxuries more when you can afford them.
Where do you draw the line between necessities and luxuries?