Understanding Fixed and Variable Expenses in Retirement
Not all retirement expenses are weighted the same when it comes to your retirement income plan. You can categorize them in all sorts of different ways, but one of the most important ways is to break out your fixed and variable expenses.
Examining your expenses in this way can give you a sense of just how flexible your spending can be. If something out of the ordinary happened, how much could you reduce your spending, and how quickly could you do it? The breakdown of your spending between fixed and variable expenses means a lot for your retirement plan.
What Are Fixed and Variable Expenses?
Fixed expenses can’t change easily or quickly and are generally required payments on longer-term items such as a mortgage or car payment. These expenses can be changed – you can refinance your mortgage or buy a different car – but it’s a hassle and generally isn’t a quick fix.
Variable expenses can be adjusted quickly. These are usually things you pay for as you go and tend to be pretty flexible – your budget for dining out, vacation expenses, etc. It’s pretty easy to say that you will eat out less or you’ll be a little bit more conscious of your budget when you’re traveling.
Some expenses fall somewhere in the middle. You have to pay for them, but you have some flexibility over how much. Like groceries – you need to eat, but you can choose to shop at Whole Foods or Aldi.
Why Do Fixed and Variable Expenses Matter?
It’s nice to classify things into neat categories, but what does this dichotomy between fixed and variable expenses mean for your retirement?
In a word: flexibility. The fewer fixed expenses you have, the more flexible your spending can be. When the unexpected occurs (and it will occur), you can adjust your spending and still have enough to take care of yourself and your essential needs.
In addition, the relationship between your fixed and variable expenses will affect the types of income you’ll want in retirement.
If more of your expenses—especially your essential ones—are fixed, then you’ll want more of your income to come from reliable sources since you need to keep a steady cash flow to cover expenses.
If more of your expenses are variable, you can feel more comfortable using your diversified investment portfolio to generate a larger portion of your income. Since the portfolio is not earmarked to cover necessities, you can more easily adjust your spending if needed in response to market volatility. You may need to give up some "nice to haves," but you won't need to worry about funding your essential needs.
Is One Type Better Than The Other?
There is no right way to handle your expenses. It all depends on what structure works best for you and how your assets are allocated to meet your future liabilities.
No matter what form your retirement expenses come in, if you don’t have a clear picture of how you’ll pay for them, now is the time to get that under control so you’ll be ready when it is time to fund your needs.
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