Fixed Costs Matter More Than Everyday Spending

Fixed Costs Matter More Than Everyday Spending

2016 has been the year of slashing budgets in the Rustic Walks household. Our Frugal August Challenge showed us what a difference small changes can make, so we’ve whittled down our spending to focus on the essentials. But we realized that we only cut back on everyday expenses. The easy choices like packing lunch over eating out, buying less expensive coffee beans, or resisting the urge to buy every wool sweater in sight (this can’t be just us, right?). Things like our rent, utilities, and transportation have yet to be put on the chopping block. In fact, they are staying the same even though we’re moving to a new apartment.

That’s the thing about small changes. They’re easy, but they also make us feel like we’re making a difference. Of course saving $200 each year by cutting back on everyday spending is a step in the right direction. But what difference does an extra $200 make if other expenses are higher than they should be? How much money could we save if we reduced our fixed costs? Certainly more than $200.

For most individuals and families, their biggest fixed cost by far is the cost of housing. Most financial advisers recommend keeping housing costs below 30% of your monthly after-tax income. For many households, that guideline is nearly impossible to follow where they live.

Cost Burdened Housing is Rising

Harvard University’s 2016 State of the Nation’s Housing report says, “in the 10 U.S. cities with the highest median housing costs, three-quarters of renter households earning $30,000 – 44,999 and half of those earning $45,000 – 74,999 were cost burdened in 2014”. That statistic means a large portion of moderate income households are paying more than half of their income toward housing. And that portion is increasing as rental prices continue to creep up.

How does this impact the rest of a household’s budget? Can it cover other needs with these odds?

50/20/30 Rule: Can It Alleviate Cost Burden?

A common budget recommendation is to follow the 50/20/30 rule for monthly expenses:

  • 50% Essential Expenses (housing, transportation, groceries, utilities)
  • 20% Financial Priorities (debt repayment, retirement contributions, savings)
  • 30% Flexible Spending (dining, shopping, health care, home supplies, etc.)

According to this budget, an individual should be able to cover all essential costs with half of their income. In some regions of the U.S. this is not difficult to achieve. But in high cost-of-living cities, housing costs alone can blow this budget out of the water.

Let’s say a single person lives in New York City and earns $2,500 per month. They take public transit, share a two-bedroom apartment with a roommate, and owe thousands of dollars in debt. According to the 50/20/30 rule, their monthly budget would look like this:

Essential Expenses:

  • Rent:  $750
  • Transportation: $115
  • Groceries: $300
  • Utilities: $100
  • Total: $1,265 (50%)

Financial Priorities:

  • Debt Payment: $300
  • Emergency Fund: $50
  • Retirement Contribution: $100
  • Travel Fund: $50
  • Total: $500 (20%)

Flexible Spending: 

  • Total: $735 (30%)

Now let’s look at the same person living in New York City on the same $2,500 monthly income, but in a cost burdened housing situation:

Essential Expenses:

  • Rent:  $1,300
  • Transportation: $115
  • Groceries: $200
  • Utilities: $100
  • Total: $1,715 (68%)

Financial Priorities:

  • Debt Payment: $300
  • Emergency Fund: $50
  • Total: $350 (14%)

Flexible Spending:

  • Total: $385 (18%)

It goes without saying that spending 68% of your income on essential expenses doesn’t leave room for much else. This person needs to cut back on groceries, savings, and all flexible spending just to get by on the same income. That’s assuming they continue to pay back their debt or cover their utilities, which can also fall behind due to cost burden.

The Harvard report also found that cost burdened households cut back spending on other necessities to compensate for higher housing costs. Things like food, clothing, health care, and savings. Families in this situation are stuck falling behind because they don’t have the ability to afford long-term financial security. 

Fixed Costs Are A Big Deal

This depiction illustrates the enormous impact of fixed costs on quality of life. If someone cannot afford basic necessities because they are burdened with sky-high fixed costs, there is no way for them to build a solid financial foundation. Unfortunately, there is no silver bullet for alleviating cost burdened households. Some people can afford to move to cheaper housing and cities, but others cannot. The fact of the matter is housing costs make a huge difference in stretching your budget. If you can make significant changes in those expenses, it could save you thousands of dollars down the line.

Many of us take on higher fixed costs than we can afford. If your income can’t cover the higher costs without sacrificing other needs, then you cannot afford them. That includes saving at least 20% of your income. If you overextend your budget, it’s a slippery slope to accumulating massive debt and creating a financial mess from which it takes years to recover.

When was the last time you took a good look at your fixed costs? The big ones we all like to avoid. Can you really afford your rent or mortgage? Your car payment? Your bills and utilities?

Challenge yourself to compare those expenses to your monthly income and determine your own expense ratios. Does your spending follow the 50/20/30 rule? If not, are there changes you can make to get there? We can nickel-and-dime ourselves all we want, but fixed costs are the true key to financial wellness. 

~Ms. RW

2 thoughts on “Fixed Costs Matter More Than Everyday Spending

  1. Since paying off our mortgage we have drastically lowered our fixed costs. It was a bear to pay that down over the years. But I’m happy that it’s gone. Having the freedom to spend money on what we want is an incredible feeling even if we don’t always spend it. It’s the feeling that we can that really is enjoyable.

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