by Stacy Francis, CFP®, CDFA
Perusing the annual report of a company that I am invested in, I got to thinking about how these two words are so much more than just accounting jargon. They affect your financial future to a much greater extent than you may think. So let’s break them down and look at what fixed, and variable expenses are – and aren’t.
What Are Fixed Expenses?
Fixed expenses are all reoccurring expenses – from rent or mortgage bills to car payments as well as tuition or childcare expenses for your children. Other bills that fall under this category include health insurance, life insurance, and essential utilities. We typically do not pay much attention to these costs, but most of our budget goes towards funding them.
These fixed expenses occur repeatedly and typically can’t be dropped with a moment’s notice, should your financial situation change. Therefore, it is essential to make sure that your fixed expenses are as low as possible, allowing you ample funds for variable costs that are often harder to control and savings. Fixed costs should take up no more than 50% of your income to make sure that you have enough breathing room in your cashflow.
Examples of Fixed Expenses:
- Health insurance
- Life insurance
- Car loan payments
- Childcare expenses
- Essential utilities
What Are Variable Expenses?
Classic examples of variable expenses are clothing, vacations, entertainment, eating out, gifts, facials, and home goods.
Many variable expenses happen sporadically only a few times a year. Think of that plane ticket you just booked to see your family in California. However, some variable costs happen every month. For example, gas, parking fees, groceries, and personal care expenses in any given month could be different from previous payments or ones you’ll make in the future.
Sporadic and ongoing variable costs can make budgeting very difficult because you never really know how much you need for this part of your monthly spending.
That being said, variable costs that can change from month to month should take up no more than 30% of your income. The positive about many of your variable expenses is that you usually have a little more control over them, and you can drop many of them if you really needed to. In addition, variable expenses are generally much easier to lower than fixed expenses like your housing.
Examples of Variable Expenses:
- Personal care expenses
- Home goods
- Eating out
- Parking fees
You might not have ever thought about savings as a monthly expense, but you should! Your goal should be to saving 20% of your income for the future. These dollars can be stashed into an emergency fund, invested in retirement, or used to kickstart your down payment savings for your first home.
If you are like most people, you struggle to save for short-term and long-term goals. According to Bankrate, one in five American adults do not save at all. Just 16 percent of those surveyed report socking away more than 15% of their income. When Bankrate asked their survey participants why they missed the mark, the top reason given was expenses. Is this the case for you too?
Fixed vs. Variable Expenses: Considerations for Your Budget
If you could use more breathing room in your budget, you should review your fixes and variable expenses, keeping the 50/30/20 rule in mind.
The 50/20/30 rule
- Fixed costs that stay the same month after month, such as your rent or mortgage, car payment, and cable bill, should take up 50% of your income.
- Variable costs that can change from month to month, such as entertainment, groceries, and clothing, should take up 30% of your income.
- Savings should take up 20% of your income.
Reviewing your fixed expenses will significantly impact how much you can save each month because they make up most of your spending. However, the negative is that reductions can be more brutal to come by and might require a change in the home you rent or own and the car you drive. More manageable fixed expenses that you can reduce can be had by changing cell phone plans, canceling extra cable channels, shopping for less expensive insurance, or refinancing your home for a lower mortgage interest rate.
The upside of having variable expenses in your budget is that you have more control over them than you do with fixed payments. It is typically easier to find opportunities to save money, but you need to think about this spending every day. If you want to save money on variable expenses, it may require some lifestyle adjustments. For example, cutting back or cutting out things like dinners or new clothes are simple ways to save. You could also save on groceries and dining out by planning meals, using coupons, or switching from name brands to generic.
Everyone deserves to splurge from time to time. But when you do – make sure you keep the 50/30/20 rule in mind. Keeping your expenses down is one of the critical factors in the quest for financial independence.
Looking to get on top of your finances? Download our free budgeting worksheet here.