Managing Variable Expenses

One of the biggest challenges in managing your finances comes from the variability and unpredictability of certain expenses. 

You weren’t planning on going out to lunch today, but you did. 

You weren’t planning on buying that new jacket, but you did. 

You weren’t planning on taking an impromptu trip to the beach last weekend, but you did. 

How can you possibly keep track of everything while also living your life?

Today I am going to talk about a highly effective strategy that will make managing your cash flow much easier. The premise is that you have fixed, known expenses and you have variable, unpredictable expenses. The goal is to separate the two, and then make your variable expenses predictable.

How do you do this? The first step is to classify your expenses as fixed or variable. Fixed expenses can be grouped into the following categories:

• Mortgage/rent

• Debt payments (vehicles, credit card, student loans, personal loans, etc)

• Household bills (gas/electricity, water/sewer, trash/recycling, internet)

• Phone

• Insurance

• Gym Membership

• Childcare

Whereas on the other hand, variable expense categories can be:

• General spending

• Gas/transportation

• Groceries

• Restaurants

• Entertainment

• Gifts

• Home expenses

• Travel

• Clothing

To make the unpredictable predictable, we first need to get an idea of what your historical averages have been for your variable expenses. To get started, I recommend reviewing your last 90 days of expenses and categorizing every transaction to understand where your money is going. 

Each transaction will go into one of the two groups: fixed, or variable. If something is consistent and predictable it goes into the fixed group. If something varies both in time and amount it goes into the variable group. 

There are several apps out there that can track your spending and automatically categorize those transactions (Mint, Empower, etc.) or you can do it manually. Personally I prefer a spreadsheet.

Once every transaction is organized, you can establish an average or baseline for these different variable expenses. Are some too high? Too low? Where do you think they should be?

From here you can take 1 of 2 approaches depending on how precise you want to be. You can either set an allowance for each category, say $300/month for restaurants and $500/month for groceries or you can lump everything together into a single number, say $2,000/month for all of your variable expenses. I prefer the latter as I don’t feel that I need to track every single category explicitly, I just want to have a limit of what this overall number should be. 

Once you’ve created a fixed number for your variable expenses (in this example $2,000/month), you can treat it like any other fixed expense. You pay it on the same day every month. You do this by creating a separate Variable Spending checking account. Once (or sometimes twice depending on cash flow needs) a month, you transfer this allowance to your spending account.

Now you have created a limit of your spending to keep it inline with your goals and your balanced cash flow. What happens if you want/need to spend more? You can, you just have to decide where that money is going to come from. 

And that is the key point to the whole strategy. 

The goal isn’t necessarily to limit you so you can’t do the things you want, it is to organize and add structure to your finances such that it is clear when you are in-bounds and when you are going out-of-bounds.

When you are forced to pull money from a different location (most likely a general or specific savings account), you have to consciously decide if that is what you really want to do. When all of your money is jumbled up in a single account, it is hard to know if you have enough for the upcoming bills, or the next round of groceries, or whatever it is. This strategy makes sure you have all of your fixed expenses planned for. You can automate your savings and investment transfers and now that you have your variable spending fixed, you can automate a transfer for that too.

Now your finances run on autopilot and all you have to do is watch that spending account. Your bills, savings, and investing are all taken care of through separate accounts that you don’t have to think about. How’s that for peace of mind?

By removing the variability of “unknown” expenses, you have eliminated the most challenging part of managing your finances. Now go out there and live your life.