In this episode, I classify Max’s costs by fixed vs. variable and discretionary vs. non-discretionary. By looking at his expenses this way, the areas of fat–the expenses that will prevent him from reaching financial freedom in less than ten years–become very obvious and actionable.
Variable and Fixed Costs
Determining whether a cost is fixed or variable is a good first step to understanding how much control Max has over that cost. The cost of gas for Max’s car is variable based on how many miles Max drives each month, so while this cost might be in the same ballpark every month, it will never be the same exact cost month after month. Max can take control of this cost by combining trips, riding a bike, using public transportation, and car pooling. He’ll purchase less gas and he’ll drive this cost down.
The lease for his apartment is a fixed cost because he’ll pay the same exact amount every month regardless of how many hours he spends in his apartment. So the idea here is to find a cheap place to live and lock that fixed cost in each month.
The good thing about variable costs is that Max has a lot of control over them as opposed to fixed costs, which are set once and generally won’t change without doing something major, like moving apartments. The downside of variable costs is that they require constant focus and monitoring to keep them in check, whereas fixed costs are set once and then forgotten about.
Here’s a simple way to think about it:
Discretionary and Non-Discretionary Costs
Discretionary costs are costs that can be curtailed or outright eliminated. (One should use their discretion when it comes to these costs.) I like to think of discretionary costs in terms of life or death. If Max doesn’t go out to dinner, will he die? I mean, he needs food to live, so that’s debatable, right? Wrong. Come on! Obviously he doesn’t have to go out to dinner. He can eat in. And save a TON of money. And with those savings he can pay down his student loans sooner and live the kind of live he wants to live, not the kind his lenders are forcing him to live.
It’s helpful to think of discretionary costs in terms of life for death because the costs that you don’t need to live (physically) are the ones that will actually prevent you from living (spiritually/hopes and dreams). I think that’s kind of beautiful.
And remember: You’ll have all kinds of money for discretionary costs AFTER you pay off your debt!
In this episode, we basically spend about five minutes talking about each of Max’s expenses to understand what makes it a fixed or variable cost and a discretionary or non-discretionary cost. Here’s is the main takeaway from the clip (click to zoom):
As you can see, almost every single one of Max’s expenses can be eliminated or scaled back. There’s hope for him yet!
The next episode is going to be a lot of fun. We get to plug revised expenses into Max’s income statement and help him turn his spending around to get him out debt in less than ten years.
Future episodes beyond episode 5 will cover the development of a simple budget that Max can use in Excel to track his income and expenses and progress to financial freedom.
Reminder: For best results, view this clip in full screen and set the resolution to 1080p.
Episode 4 Materials