Friday, April 30, 2010

Controlling Fixed Costs (a Personal Experience)

For the first few posts I will discuss Fixed Costs versus Variable Costs. To define the terms, fixed costs are those that come due regardless of what income you receive. A mortgage is a fixed cost. If you lose your job, the mortgage payment still must be paid. Income taxes are variable costs – no income, no income tax.

Many, many years ago I got promoted and moved from the Boston area to the greater NYC area. While in Boston, I started a night school MBA program at Boston University. For a variety of reasons I couldn’t finish the program in New York. I decided I wanted to return to BU full-time for one year and finish my MBA. Great in theory, but could I afford it?

Each year I developed and followed decent budgets. Even with two growing children and a stay-at-home wife, we spent less than we earned. We knew we had to save for the kids’ college and our retirement.

With the idea of taking a year’s leave of absence, I developed a budget assuming $0 income. On the expense side I deleted all variable costs – those we could forgo for the year. I was shocked to discover that my fixed expenses were considerably higher than my gross earnings had been before my move from Boston four years earlier. How did that happen?

We were living within our means. We had no credit card debt. No car loans. But,

  • We bought a more expensive house, so the mortgage, real estate taxes, insurance premiums and upkeep all increased.
  • We traded in two older cars for newer cars. We paid cash, but auto insurance costs grew significantly.
  • We had two children, who thought they should eat and have clothes and go to the doctor.
  • We enrolled the older child in pre-school, which we now thought of as a necessity.

It’s not that we couldn’t afford each of those decisions, but each came with fixed costs attached, and over time the fixed costs added up. Fortunately, my company offered me part-time employment while I studied in Boston, which also covered medical insurance. That was enough to make the deal affordable without taking out student loans.

I was certainly fortunate to be able to go to school without going into debt, but I had learned an important lesson from the exercise. From that point on I made sure I understood not only the short-term implications of every buying decision, but the long-term ramifications.

~ Jim

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