Once you finally work up the courage to create a monthly budget, one challenge remains: What is the difference between a fixed and variable expense? And how does the role of these two fit within a budget, anyway?
These terms aren’t just financial jargon, they’re necessary for anyone tring to manage their cash flow to understand. To put it simply: If you want to properly maintain a budget, you need to understand the difference between these types of expenses.
What is a Fixed Expense?
Fixed expenses: Expenses that largely remain constant, such as your monthly rent or mortgage.
Within your budget, fixed expenses are paid at regular intervals and generally cost the same amount. We say generally, because the cost of a fixed expense can change occasionally – for example, your monthly may be the same amount for the first year, but is likely to increase upon renewal.
Not all fixed expenses are monthly. They can occur weekly, quarterly, twice a year or yearly. Knowing the interval of your bills is essential for the budgeting process.
Fixed Expense Examples:
- Rent or mortgage payments.
- Property taxes.
- Car payments.
- Child care costs.
- Insurance premiums.
- Utility bills.
- Phone bills.
- Loan payments.
- Tutition fees.
- Gym memberships.
What is a Variable Expense?
Variable expenses: Expenses that vary month to month or are unpredictable, such as dining out or car repairs.
Unlike fixed expenses, variable expenses change regularly – they’re less predictable and, at times, more volatile. In many cases, variable expenses are directly influenced by the choices you make day to day. But there are many variable expenses that are necessary and unavoidable.
Variable Expense Examples:
- Groceries, or dining out.
- Gas costs.
- Personal care.
- Medical expenses.
- Entertainment costs.
- Home repairs.
- Car repairs.
- Ride sharing.
- Pet expenses.
Some variable expenses can be more easily controlled than others. For example, you can limit the cost of dining out on a given month by limiting the frequency or selecting less expensive restaurants. But a variable expense due to an emergency hospital visit, for example, is far less adjustable.
Because of their unpredictability, some households struggle to track and plan for variable expenses. If you need help doing so, read on.
Related: How to Create a Monthly Budget
How to Budget for Fixed and Variable Expenses
When creating a budget, it’s easiest to start planning for your essential expenses first, which are typically fixed expenses. This includes housing (rent/mortgage), car payments, insurance premiums and child care costs. Of course, it’s important that these areas are covered each month before you decide how to divide the remainder of your budget.
Now comes the challenging part: Budgeting for variable expenses is an inexact science, but here are two ways to make it easier.
Calculate the Average of Your Variable Expenses
If you calculate what you spend on variable expenses on average, you can use that average as a baseline in a given budget category (i.e. groceries).
To find your average spend, add up the total cost of the budget category over the last year and divide that number by 12. You could also use the average of the last six months – or even three months – if the variable expenses have become more or less expensive as of recent.
Because there will be months when you spend more and months when you spend less, you can utilize a strategy called sinking funds. Sinking funds work like this: At the end of a month where your variable expenses were less than average, you divert the remaining money into a sinking fund so that, when a high-cost month comes along, you can pull from those savings to cover the expenses.
Give Yourself a “Spending Cushion” for Variable Expenses
Another way to plan for variable expenses is to give yourself a cushion by budgeting for more than you believe you’ll spend.
This approach only works if you have enough wiggle room in your budget. However, you could identify nonessential spending from previous months and target areas to reduce spending, which will allow smaller budgets to adopt this approach.
If, at the end of the month, you have money left over, you can also utilize the sinking fund strategy. Or, in thinking more long-term, allot that money towards an emergency fund, retirement accounts or investments.
Need more personalized assistance? Book a complimentary consultation with our team of financial advisors. We’re here to help answer your questions, or provide more comprehensive planning for you and your family.