Discretionary income is an intuitive concept, but it is worth more than a passing thought. Understanding your discretionary income can help you align your thinking with your long-term financial goals. Bottom Line Personal asked Eric Amzalag, CEO of Peak Financial Planning, to help explain the concept and what it means to you…
What is discretionary income?
As the term suggests, discretionary income is the portion of your money over which you have control in terms of how it will be spent. In other words, it is what’s left after you’ve paid for your necessities such as food, shelter and utilities. Example: If you make $10,000 per month and must spend $5,000 on necessities, you can decide what to do with the remaining $5,000? Perhaps buy a nicer car or a diamond ring or invest in your retirement.
While there are numerous discretionary income calculators online, most are built around federal student-loan-repayment programs. For financial-planning purposes, it is best to just categorize your costs into two buckets—mandatory costs and discretionary spending.
Why is discretionary income important?
Discretionary income is the money that has the greatest potential impact on your financial future. Making your car payment won’t exactly bring dividends, but with the discretionary portion of your money, you can make bad or good choices—buy new clothes every month…or invest in a college savings fund, for example?
Are there gray areas of discretionary income?
Sometimes we get bogged down by the fact that not all “non-discretionary” spending is truly non-discretionary. Example: No one forced you to buy a house with a $5,000 mortgage payment instead of renting a studio apartment. And what about things like replacing that aging garage roof—should that be considered discretionary or mandatory spending? After all, you don’t absolutely need to do it this year, but it does fall under the “shelter” category.
For financial-planning purposes, focus on your current commitments. If you have two car payments and a big mortgage, consider those non-discretionary. Put the roof repair into whichever category feels right. Don’t let a perfect plan be the enemy of a plan that you will execute.
Can you change your discretionary income?
Something people often overlook is that you can increase your discretionary income without earning more money by reducing some fixed costs.
Example #1: If you’ve been paying $2,000 a month for an apartment that’s bigger than you need, that is a mandatory expense until the lease is up…but then rent becomes somewhat more discretionary. You could downgrade to a smaller apartment with rent of $1,250, and you become richer by $750 per month…that’s money you can use to invest in your future.
Example #2: Your utility bill does not fall under discretionary expenses. But you can use some discretionary income to upgrade to more efficient windows and lower your monthly utility bill. In that way, you’ve grown your discretionary income by wisely spending a portion of it.
