Your ability to control and manage your expenses significantly influences the success of your financial plans and your satisfaction with life as well.
Below are 5 ways to view your expenses. Audit each category in your own spending to better understand and more effectively manage your cash flow and improve the outcome of your financial planning.
1. Fixed Expenses
Fixed expenses are recurring, consistent costs that you can anticipate and expect to occur regularly. These typically include rent or mortgage payments, utilities, phone, internet, insurance premiums, property taxes, subscription payments, gym membership, minimum monthly debt payments and so on.
Given the predictability of these expenses, this is generally an area of your spending that is fairly simple to calculate and will not have too much variability over a year.
Time frames for fixed expenses
Generally, your fixed expenses occur on a monthly basis (like your mortgage or rent payment, utilities and gym membership). However, you will also want to consider regular annual, semi-annual, or less frequent costs like certain insurance premiums (life, LTC, auto, homeowner’s), vehicle registration, subscriptions (your annual Amazon Prime membership), to name a few.
Rule of thumb for fixed expenses
If you are still working, a good rule of thumb is to have no more than 50% of your monthly after-tax income allocated towards fixed expenses. If you live in a high cost of living area (think NYC or San Francisco), this percentage may look more like 60%. Your after-tax monthly income is essentially what is deposited into your bank account after taxes and deductions each month while you are working.
Auditing your fixed expenses
Because fixed expenses are well, fixed, you might think that you don’t have as much control over them. However, it’s essential to monitor various aspects of your fixed expenses to maintain financial stability and make informed decisions. Here are some strategies to help you reduce or adjust these expenses:
- Refinance Loans: Consider refinancing your mortgage or other loans to secure lower interest rates, which can reduce your monthly payments.
- Make Good Tax Decisions: Make sure you are keeping taxes in mind when making financial decisions. Roth conversions, deductible expenses and other factors can reduce what you pay to the I.R.S.
- Review Insurance Policies: Periodically assess and shop your policies to ensure you have adequate coverage at the lowest price.
- Negotiate Contracts: Negotiate with service providers like cable, internet, and phone companies for better rates, or explore more affordable plans.
- Transportation: Consider public transportation, carpooling, or ridesharing as alternatives to owning a car, which can save on fuel, maintenance, and insurance costs.
- Downsize: If your living situation allows, consider downsizing to a smaller home or apartment to reduce mortgage or rent payments and related expenses.
- Utilities: Be mindful of your water, electricity, and gas consumption. Install energy-saving appliances and smart thermostats to cut costs. Unplug devices when not in use.
- Refinance Student Loans: If you have outstanding student loans, explore refinancing options to potentially secure lower interest rates and reduce monthly payments.
- Healthcare: Review your healthcare plan options during open enrollment periods. Consider high-deductible health plans or health savings accounts (HSAs) for potential cost savings.
- Retirement Contributions: While it’s important to save for retirement, adjust your contributions if necessary, especially if you have high-interest debt or immediate financial concerns.
2. Variable Expenses
Variable expenses are costs that can fluctuate from month to month, and they are often discretionary in nature, meaning they can be adjusted or controlled based on your spending choices. These expenses are typically less predictable than fixed expenses and can change based on your lifestyle, needs, and preferences.
This spending category frequently leaves people pondering, “Where did my money go?” Variable expenses include groceries, eating out, gas, clothing, personal care, social events, hobbies, among others.
Rule of thumb for variable expenses
A useful guideline is to aim for keeping your variable spending within 30% of your monthly net take-home pay. If $10,000 hits your bank account each month while you are working, for example, then you would want to try to spend no more than $3,000 each month on variable costs. Oftentimes, people use one credit card as a way to track their variable spending to ensure they are spending in line with their established limit.
Controlling variable spending
Variable spending can be hard to control if you aren’t careful. After all, it varies.
Here are a few tips:
- Track closely. If you are trying to control your budget, you may need to track variable spending particularly closely.
- Be willing to make trade offs. If your spending is skyrocketing one month in one variable category, you may need to spend less in another category.
- Consider an envelope strategy. Use cash or envelopes for certain variable expenses. When the cash is gone from an envelope, you know you’ve reached your limit for that category.
Controlling variable spending is an ongoing process that requires discipline and self-awareness. By being intentional about your discretionary expenses, you can enjoy the things that matter most to you while staying within your financial means and working toward your long-term financial objectives.
3. Infrequent, but Expected Expenses
Even when you believe you’ve meticulously budgeted for your monthly expenses, infrequent costs have a way of cropping up during the year, often slipping your mind. These might include occasional expenses like gift-giving, tuition payments, vacations, charitable donations, and other costs that don’t happen monthly but a few times a year.
To avoid surprises in your cash flow throughout the year, you may want to consider adding a “miscellaneous” category in your spending plan to account for these infrequent, but expected expenses.
If you’re aware that you generally incur $1,500 in sporadic expenses annually, you could incorporate a monthly budget item of $125 within your fixed expenses. By doing so, you’ll ensure that you have the necessary funds available when these expenses pop up during the year.
4. Essential and Discretionary Expenses
It’s helpful not only while you are working, but also while you are in retirement, to distinguish between essential and discretionary expenses. If you consider each expense in your spending plan, you can determine whether it qualifies as a need (mandatory/unavoidable) or a want (subject to choice/preference).
Essential and discretionary expenses are based on your personal priorities
The most crucial aspect of categorizing expenses into discretionary and essential lies in aligning personal spending with one’s priorities and long-term goals. By distinguishing between these categories, individuals can ensure that they meet their fundamental needs while consciously directing resources toward what truly matters to them.
This clarity in financial management empowers individuals to make informed decisions, plan for emergencies, reduce unnecessary spending, and track progress toward their objectives, ultimately reducing financial stress and enhancing overall well-being. In essence, this categorization serves as a practical tool for achieving financial security and pursuing one’s most cherished aspirations.
These categorizations can change over time
This distinction can also be very subjective and can change over time. For example, you may decide while you are working that all of your TV subscriptions (Netflix, Hulu, HBO, Apple TV, Showtime, and so on) are nice-to-have, but not necessarily mandatory. However, once you’re in the early months of retirement, you realize you have a lot more time than you imagined and you want to spend some of that time enjoying all of your favorite TV shows. Those subscriptions may start to feel a lot more essential to you!
In challenging stock market conditions or when faced with a job loss, the ability to promptly identify and reduce non-essential or discretionary expenses can significantly ease your journey through these tough situations, reducing any financial stress.
Use a rule of thumb for discretionary and essential expenses
There are two popular rules of thumb for allocating your spending.
- The 50/30/20 rule suggests that essential expenses should be 50% of your budget and you can dedicate about 30% to discretionary spending with 20% going to savings.
- A different rule of thumb says that 70% of your budget should go toward essential expenses with 20% to savings and only 10% to discretionary spending.
These rules of thumb are just a starting point and should be adjusted based on your individual priorities and circumstances.
5. Expenses Unique to Your Personal Financial Situation
Along with personal, lifestyle expenses, you may also have other special circumstance expenses, like costs related to a rental property you own, for instance.
For rental properties, there’s often expenses related to owning or maintaining the property. These expenses may include mortgage payments, property taxes, maintenance, utilities, property management, homeowners insurance, repairs, and more. Much like your personal expenses, you can classify your rental property costs into fixed and variable categories.
You should also distinguish between operating expenses and capital expenses. Operating expenses, such as insurance or maintenance, are necessary for the daily upkeep of your property. On the other hand, capital expenses, such as a new roof or a kitchen renovation, enhance your property’s value or extend the life of your property.
Why Auditing Your Spending Can Be Very Impactful
If you take the time to review your spending periodically, you may start to uncover some patterns.
You may already know of some areas in your spending that can be improved, which is why you tend to wince when you look at the Food and Dining category of your expenses. Some categories may surprise you as well if you haven’t revisited them in a while. You knew gas was expensive, but goodness it really adds up over the month.
Whether you revisit your spending plan quarterly, semi-annually or annually, it’s important to assess or audit your patterns and adjust your spending behavior accordingly to align with your values, goals and set yourself up for future financial success.
You might find that making small lifestyle adjustments can help you fine-tune both your essential and discretionary expenses, enabling you to achieve your financial goals more efficiently.
Be prepared to make adjustments up and down as needed
Adjusting your spending allows you to navigate through market downturns and other unexpected financial challenges. At times, you may also find that you can dial your spending up and expand your lifestyle after years of hard work, saving, and investing.
The inflation rate, or the rate at which the price of goods and services increases, stood at 7% in 2021 and 6.5% in 2022. If you haven’t recently assessed your expenses, you may be surprised by how much your spending has risen.
Use the NewRetirement Planner to Help You Audit and Plan Your Spending
Gaining a better understanding of your expenses can feel like a daunting task. However, you don’t have to do it alone.
The NewRetirement Planner enables you to model your expenses through the Basic Budgeter. You can reflect how you spend today and you also can model how your spending might change in the future, by adding expenses for different phases of your life.
PlannerPlus subscribers can also take advantage of the Detailed Budgeter with additional features including:
- Planning for essential and discretionary expenses (Must Spend vs. Like to Spend)
- Adding tax treatment to specific expenses
- Varying your spending in 75+ categories
This powerful tool helps you establish a current and future spending plan, so you can be confident your finances will support you through life’s various phases.
