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Most of us desire to spend money on travel, vacations, entertainment and luxury items to live a fulfilling life. In order to do these things, people are more and more focused on finding ways to generate more income. Especially when you consider the constant increase costs from bills, mortgages, loan payments. Somehow it always feels like income grows slower than these expenses.
Understanding Discretionary Income can help us identify how much one can spend on non-essentials and with some proper planning and budgeting you can enjoy these without having to compromise your necessities.
What Is Discretionary Income?
Discretionary Income is the amount of money you have left after all your essential expenses have been paid. Before going further in discussing what Discretionary Income is, let us first define what are the essential and nonessential expenditures.
Essential expenditures are the expenditures that are essential for an individual to survive or is necessary for daily living. These include, but are not limited to:
- Shelter (Mortgage, Rent)
- Transportation (Fare, Gasoline)
- Taxes (Income Tax, Sales Tax)
- Medical needs (Insurance, Medication)
- Loan Payments
In contrast with essential expenditures, nonessential expenditures are expenses that are “nice to have” but not required for survival. Instead, it is an expense to satisfy an individual’s wants. Examples of nonessential expenditures include:
- Luxury items such as jewelry, designer clothes, and perfumes
- Vacations or trips (excluding work trips as those will help you make more money in the long term).
- Entertainment expenditures (music, concert, movies, festivals, theatrical plays, sports, art exhibits, museum)
- Nonessential food items (desserts such as ice cream, alcohol, cigarettes, soft drinks, juices)
- Recreational activities (hiking, swimming, camping, and other outdoor activities)
- Expensive cars
- Other nonessential goods and services
Some individuals will also see purchases such as cell phones, television sets, tablets or computers as non-essential but that is really based on the individual and their work. A computer and cell phone may be a job requirement for some but if you’re an painter, it may be a discretionary expense.
Discretionary Income vs. Disposable Income
It is a common mistake to interchange Discretionary Income with Disposable Income. This is because both of these terms refer to an amount available for spending. Both incomes are similar, but there are several key differences.
Disposable Income is best known as ‘after-tax’ income. Disposable Income is calculated simply by taking a households total income and subtracting taxes. What is left is a Disposable incomes.
From there, if you take away your essential expenses from your Disposable incomes, you get your Discretionary Income. Clearly Disposable Income will always be higher than Discretionary Income.
How to Calculate Your Discretionary Income
Now we know what Discretionary Income is, let us find out how we calculate for it. Since we have been discussing what Discretionary Income exactly is, it will be easy for us to compute for an individual using their income and their essential expenditures. From there, we can determine the amount of Discretionary Income, and we can know how much we can spend on other things or how much we can save for future use.
For example, Joe works at an undisclosed corporation and earns around $10,000 a month. From there, let’s say the government deducts a total of 35% for simplicity. That leaves Joe with $7,500 per month as income. After averaging and listing his daily expenses for food, transportation, and other necessary expenses, he figured that his essential expenditures reach up to $4,000.
Subtracting that amount will leave him with $3,500. This amount left is what we call Discretionary Income. After factoring out the taxes and essential expenditures, this is the amount that Joe can safely use for non-essentials (travel, entertainment, investing, etc).
Discretionary Income typically doesn’t fluctuate too much as often essential expenses like food, housing, utilities, etc are pretty consistent each month. This can help in create sound budgets and allows you to determine how long it would take to save up for non-essential spending like vacations and luxury items.
Why Knowing Your Discretionary Is Important
Knowing you Discretionary Income is essential as it gives you an understanding of what your recurring costs are that you need for basic survival. Here are some reasons to make sure you accurate understand your Discretionary Income amount.
Manage your nonessential expenses wisely
First, knowing our Discretionary Income will allow us to manage your nonessential expenses properly. Given the previous example of $3,500 worth of discretionary income, this amount can help us in gauging how much we should be spent on specific items like a vacation, electronics, or other things, especially large purchases.
Getting ahead of your loan payment
Another reason to get a good handle on these numbers is in case you are looking to get a loan or mortgage. Knowing how much you can pay monthly above your essentials can help you make sure you don’t over extend yourself with a loan that is beyond your reach.
Discretionary Income is ‘leftover’ money from the amount spent over essential requirements. So you can use this amount to determine how much you can use as payment money (e.g., a loan).
A more efficient way of saving
Lastly, understanding your essential costs versus your gross income can help you figure out how long you need to save in order to create a savings nest eff. It is always important to have a certain amount of savings for a rainy day, such as employment loss, family emergencies, health issue or legal trouble.
We would suggest only once you have accumulated that level of savings where you are comfortable should you look at more extravagant expenses. And even then, the trade off will be whether to spend or to look at investment opportunities such as stock trading or real estate.
With all of these in mind, there is a lot of importance in understanding our discretionary income and making the right decisions for our lifestyle
Ways of Increasing Discretionary Income
There are a few ways of increasing your Discretionary Income. Some of it is obvious and can quickly be done. However, some are not so obvious and difficult to do. Take note that these are just some general tips, and it varies per individual.
Increase Your Sources Of Income
One way to increase your Discretionary Income is to increase the streams of income you get. There are many ways to achieve this. You can switch to a higher paying job, request a salary raise, acquire side hustle jobs, invest in something that can create repetitive cash-flow or anything that will grow money inflow.
Given that your essential expenditures remain the same, increasing your income will definitely help in raising your Discretionary Income. Make sure that when switching jobs, it would not significantly affect your expenses. For example, if you need to commute further which will increase the wear and tear on your car, add gas, tolls and increase your insurance premiums, can actually decrease your net income.
Aside from switching jobs or asking for a raise, a side hustle is also a great way to increase your income. Things like proofreading, writing an article, tutoring, having a website, or any other money making venture will help you improve your income generation. A lot of side hustle jobs now are being done online from the comforts of your own home. This setup will reduce the hassle and expense of traveling.
Having side hustles also increases your productivity. Instead of spending your time watching Netflix or surfing the net all night, you get to have additional income through these part-time jobs.
Read Side Hustle: From Idea to Income in 27 Days by Chris Guillebeau to help you get started with your part-time job.
Invest Your Money
Another way of increasing your Discretionary Income is to invest it – whether it is in stock, bonds, or real estate. Initial investment takes a portion of your Discretionary Income, but since investing is a passive way of generating income, it will increase your income over time. The more investments one has, the higher the increase in your income. Make sure, however, to weigh your investment options since not all investment are created equal. Some options yield low income with low risk involved. On the other hand, other options will generate high income but are tied with a high risk. This is where the diversification of the portfolio will come in.
Keep in mind that it is not recommended to put all your money into just one basket. This kind of approach is more susceptible to failure. Consider these factors and make sure to have a backup or an emergency fund in case one or many of your investments fail. It is best to consult an expert regarding these to prevent these hardships.
The Intelligent Investor by Benjamin Graham will teach you the ins and outs of the investment world.
Start A Small Business
If you are not confident enough about your investment skills, then maybe another option for you is to start up a small business. You can establish this using a small initial investment. Then gradually work your way into growing your business while having a regular income from your day job. There are a lot of opportunities when it comes to business but note that with any venture, there is an opportunity for failure.
You will most likely reap the fruits of your labor long term. There are a lot of industries that you can try – food, clothing, transportation, trading, or anything products or services you can sell. Make sure that the company you will establish will be feasible in the area you plan on having it. You may also depend on the current market trends or make sure that your offerings are something that people would want to visit or buy.
How to Start your First Business
There are a few steps on how you can start with your business. It involves collaborative planning, data analysis, financial decisions, consumer insights, and a series of legal activities. Here is a step-by-step process in establishing your first business:
- Conduct Market Research: As a businessperson, you should measure whether there is an opportunity for your idea to transform into a successful business. The way to go about this is to gather all data and information about the business landscape, customers, and consumers in the said area. This will also be the best avenue for you to check the competition. Make sure the demand for you product or service exists before starting.
- Draft A Business Plan: The foundation of your company should be a business plan. It contains the organization structure, business strategies, and product and service details. You will eventually use this to convince potential investors.
- Fund The Business: Make sure to prepare your financial goals and forecast. In case you still do not have money on hand, you will need to present this as well to your potential investors.
- Establish Basic Details: You will be required to finalize some basic details such as business location, business structure, and business name.
- Register The Business: Once you have picked the most suitable business name, you need to protect your brand by making it legal. You also have to apply for licenses and permits. Take note that the requirements will vary depending on your state, location, and industry.
Improve Your Spending Habits
Besides investing and generating more income, another way of increasing your Discretionary Income is by spending less. Spending less is often the most straightforward strategy. Listed below are some ways on areas that can have a little bit of cost-cutting.
- Transportation: biking instead of riding a bus or try carpool
- Food: cooking in batches or finding cheaper grocery stores
- Utilities: conserving water and electricity use, run household items during non peak times
- Housing: moving to a cheaper apartment or unit, get more roommates
- Shop around and negotiate – Shop around when buying essentials like finding insurance and buying a car and always negotiate.
- Drop the Brands – sometime you can save a ton of money buying the generic version of items like medicine, clothes, furniture and accessories.
Just make sure that when doing this, you will not be sacrificing too much and make poor health decisions.
Aside from the cost-cutting techniques on the essentials, it is also possible to spend less on the nonessential ones. You can reduce the number of night outs you’ll be attending to. You can also lower the frequency of vacation trips, reduce bar visits, or avoid spending on electronics. If you really want to buy all of these nonessentials, you have to allocate money regularly until you reach the intended amount.
All in all, there are a lot of ways of increasing your Discretionary Income. You can increase your income streams, invest in a business or a long-term investment. Or simply just spend less and use the saved money to generate more income. Mixing and matching correctly depending on your needs and available resources will surely enable you to increase your Discretionary Income.
To know more about the basics of Discretionary Income, you may check out the book entitled Disposable and Discretionary Income.