IF THERE’S ONE NUMBER that drives our financial lives, it’s our fixed living costs. We’re talking here about regularly recurring expenses that are pretty much unavoidable, such as mortgage or rent, car payments, property taxes, utilities, insurance premiums and groceries.
Why are fixed living costs so important? There are five reasons:
1. The lower our fixed living costs, the easier it is to save. I believe many Americans would love to save more, but simply can’t, because they’re boxed in by hefty monthly expenses. I advise keeping total fixed living costs to 50% or less of pretax income—and yet the typical American family spends that much just on their home and car.
2. Low fixed costs mean we need less income to retire in comfort. One rule of thumb says retirees should aim for 80% of their final salary. But if our fixed living costs are low, we might be able to retire comfortably with just 50% of our preretirement income.
That makes saving for retirement far less onerous, because we might only need a nest egg that’s half as big. Why half? Suppose Social Security benefits will replicate 20% of our final salary. To get to 50%, or 30 percentage points more than this 20%, we’d need a nest egg that’s half the size of the portfolio required to hit 80%, or 60 percentage points more. One way to slash fixed costs: Get our mortgage and other debts paid off before we quit the workforce, and perhaps also trade down to a smaller place.
3. If we hold down our fixed costs, we can probably make do with a smaller emergency fund. After all, if we get laid off, we’ll need to draw less from savings every month to keep the household running.
4. Lower fixed monthly costs mean less stress. After paying each month’s fixed costs, we should be left with plenty of financial breathing room. Result: We’re less likely to be living paycheck to paycheck and worrying constantly about how to pay the bills.
5. Lower fixed costs can translate into greater happiness. The spending that brings us the most pleasure tends to be discretionary spending—things like eating out, attending concerts and going on vacation. If we have lower fixed costs, we’ll have more money left over for the fun stuff.
Follow Jonathan on Twitter @ClementsMoney and on Facebook.
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