In their 2003 book The Two-Income Trap, Harvard law professor Elizabeth
Warren and her daughter, personal-finance expert Amelia Warren Tyagi,
examined bankruptcy records to uncover the biggest risk to Americans'
financial welfare. The problem, they found, is that too many of us
haven't built up enough of a cushion to see us through bad times. As a
result, many of us are often just a health crisis or a job loss away
from financial disaster. Now, in All Your Worth: The Ultimate Lifetime
Money Plan, they offer practical advice for anyone whose income simply
doesn't leave enough for saving. You'll be glad to hear it doesn't
involve cutting out your morning latte.

Q Experts usually say that if you feel strapped, cut back on unnecessary
expenses. But you encourage people to indulge up to a point. Why?

TYAGI The old belief was that the only reason people get into trouble is
because they spend too much on stupid stuff. That just isn't true. There
certainly are people who fritter money away on little things, but in The
Two-Income Trap, we found that the typical family today spends less on
the little things than their parents did. They spend less on food, even
when you account for eating out, and less on clothing. But they're
spending a lot more on basics like housing, cars, preschool for the
kids, child care and health care.

WARREN Anyone who is budgeted to the edge and feels there's no money for
fun does not have a lifetime money plan. All of life becomes cheating
and feeling deprived and anxious. No one can live like that.

Q So you argue for setting aside 30% of your income for fun. Isn't that
a lot?

WARREN The worst advice I've ever read is "cut out the lattes to pay off
your debt." You can cut out all the lattes, but unless you're floating a
boat in them, it won't be enough to pay the interest on your debt.

TYAGI The key is to make dollar cuts before you spend time on penny cuts.

Q But small stuff can add up, can't it?

TYAGI Yes, so you need to give yourself an overall budget, put that
amount of cash in your wallet--once a week, say--and don't pull out the
plastic. Cash lets you relax because you have freedom to buy what you
want and know what you can afford.

Q What's wrong with using credit cards if you pay your balance every
month?

TYAGI Researchers have found that when people use plastic rather than
cash, they spend more. When you use cash, you know exactly what you're
spending.

WARREN Cash is the key to confidence. It lets you track your spending as
you go, so you don't have to second-guess yourself or be surprised at
the end of the month.

Q Besides 30% for "wants," your Balanced Money Formula recommends
budgeting 50% for "must-haves" and 20% for savings . Why is it important
to get the must-haves down to 50%?

WARREN It's sustainable, and it's safe. If you lose your job you'll more
easily get by on one income or an unemployment check. If you face a
disability--as one in four people will before they reach retirement
age--you're more likely to be able to survive on a disability check.

Q I thought that's what an emergency fund was for. If you're saving a
lot, can't you go above 50% on fixed expenses?

TYAGI We agree it's a good idea to have six months' worth of expenses in
liquid savings. And with that savings, a little flexibility in the other
categories is fine. But the reality is that most Americans not only
aren't saving, they're carrying a whole lot of credit-card debt to boot.
So we suggest building in a little extra slack.

Q To many people, getting fixed expenses below 50% without overhauling
their lifestyle sounds impossible.

TYAGI There are lots of relatively easy cuts that nobody ever thinks
about.

WARREN A big one is insurance. Most people are paying way too much. If
you spend an afternoon shopping for car insurance and homeowners
insurance, you may be able to free up hundreds of dollars a month. Get
at least five quotes and ask your current insurer to beat them.

TYAGI Sometimes you can get a big discount by buying all your insurance
from one company. There are also discounts for nonsmokers, for
installing burglar alarms and smoke detectors, or for reaching the age
of 55 or 65.

Q What else?

TYAGI Get a flexible spending account if your employer offers one. You
pay medical expenses tax-free, which is like a 30% discount on all
medical bills.

WARREN And there are lots of ways to save on medical insurance. If your
company offers several plans, the lowest-cost plan may be the best
value. It's amazing how many people will pay an extra $50 a paycheck
just to go to a dermatologist who's 20 minutes closer to home.

TYAGI Also, get rid of insurance you don't need. This includes
credit-card loss and identity-theft protection, mortgage insurance and
accidental-death insurance.

Q You point to several other areas where we don't comparison shop enough.

TYAGI Car loans is one: These days, car makers earn more on financing
than on selling cars. So don't just take the dealer's rate. Check banks
and credit unions.

WARREN If you haven't checked your mortgage rate in the past year, it's
worth shopping. A difference of half a percentage point can mean tens of
thousands of dollars over time. Get at least five quotes and play
brokers off one another. And be sure to shop all the pieces, not just
the interest rate. Shop for points, fees and closing costs as well.

Q Why devote 20% of income to savings?

WARREN We want to make sure you'll have enough to retire--which experts
say requires saving 10% of take-home pay--plus enough for your dreams
beyond retirement, like paying off your home, buying a cabin by the
lake, helping your kids through college.

TYAGI We also include paying off debt in this category. That's a kind of
savings too, because if you have money in the bank and aren't paying off
credit-card debt, you're fooling yourself. You're installing smoke
detectors in the hallway while there's a grease fire in your kitchen.

Q But everyone has some debt. Is it really the financial equivalent of a
grease fire?

WARREN With debt for a home, car or education, at least you have
something valuable once you pay it off. Other kinds of debt steal from
the future.

Q Besides avoiding bad debt, what's the most important step for your
future?

TYAGI The key is to take stock and get in balance. That's not a gimmick,
it's a lifelong plan. It's "get rich slow."

DIVIDE AND CONQUER

In All Your Worth, Elizabeth Warren and Amelia Warren Tyagi describe a
simple formula they say will virtually eliminate your money worries. To
apply their Balanced Money Formula, divide your take-home pay into three
parts, distributed as follows: