Fixed expenses are those that do not change from month to month, such as your mortgage payment or rent, insurance premiums and gym membership. Variable expenses, on the other hand, fluctuate from month to month. They include what you spend on food, transportation, medical bills and entertainment.
The second filter distinguishes essential from discretionary, or non-essential, expenses. More informally, it distinguishes needs from wants.
Essential expenses are those you literally could not do without, such as food, clothing and housing. While you can make choices to keep spending in these areas under control—for instance, not eating out regularly and choosing a smaller house or apartment than you'd like—you can't cut out these expenses entirely.
Discretionary expenses, on the other hand, are more often than not "nice to haves," such as a new cell phone or pair of shoes, but aren't necessary. While this category is probably the easiest place to make cuts in your budget, you don't need to do away with everything in this group to make a positive difference in your spending habits.
By categorizing your expenses, it will become clear where you spend the least and where you spend the most. You can also use your spending ratio as a guide to further clarify the areas that could use some trimming. A spending ratio identifies how much of your total income is going toward paying for a particular expense.
For example, if your income is $60,000 and you spent $20,000 on housing last year, divide what you spend on housing by your total income to find the spending ratio. In this example it would be 33%.
Since a standard guideline for housing expenses is 28% of income, you may want to reduce your housing costs and free up money to put toward other goals, such as your retirement. If this isn't possible, either because you aren't able or don't want to move, you'll have to find other areas in which to cut expenses.