Budget Using Fixed vs Variable

In order to budget effectively we need to understand the way we spend our money and how the budget categories behave each month. A common method that finance planners use to do this is to identify each expense as either fixed or variable. 

Fixed expenses are those with amounts that change very little from month to month. Your largest expenses each month are likely fixed. Examples of fixed expenses are tithing, mortgages, car payments and car insurance. These expenses are often part of long-term agreements (debt). Even small fixed expenses can add up to significant annual expenses (a small $25 monthly payment adds up to a $300 annual payment). The key to managing these types of expenses is to enter into few long-term agreements.

Variable expenses are those that can change from month to month or are unexpected. Examples of these include food, clothing, utilities, car repair, home maintenance and medical. These expenses vary due to individual impulses, changes in market prices and often involve short-term agreements. The key to managing variable expenses is to treat them like fixed expenses. I’ll talk about this more in a bit.

Each expense should be classified in one of these categories, however, there are some expenses that may exhibit both fixed and variable traits. Take a cell phone bill as an example. Many cell phone plans have a fixed portion (monthly rate) and a variable portion (extra cost for additional minutes or data). If this is the case, and for simplicity sake, you can treat the whole expense as variable.

How do I use the fixed variable method to manage my budget?

A healthy budget has a controllable amount of fixed cost. That way if income drops there is enough cash flow available to meet all other obligations--low fixed costs are sustainable. Many people suffer from fixed costs that are too high due to consumer, vehicle, student and mortgage debt. Assuming the fixed cost is related to an asset with sufficient market value, the remedy for these people is to trade down the asset thereby trading down the corresponding liability. This is why it is so important that before we enter into any long-term financial arrangement it’s critical that we don’t let our wants speak louder than our needs. Unless you have extenuating circumstances, non-secured debt such as most consumer debt can only be lowered by paying it off.

Another trait of a healthy budget is one that treats variable expenses like fixed expenses. For variable expenses that can’t be predicted you can make monthly advance payments to a savings account. This is called a sinking fund. Although these expenses may be unknown at the time they still can be planned for well in advance. For recurring expenses like groceries we can treat them as variable by not overspending the budget. Techniques such as envelopes and spending freezes are excellent ways to keep these recurring items within a fixed budget.

This concept of fixing our variable expenses is also a critical component of the debt snowball technique for long term financial planning. It is also the best way to keep debt from coming back.