Understanding Discretionary Income

One simple question told me all I needed to know. “How much money do you have left over after all of your bills are paid?” It wasn’t the actual answer to the question that I was looking for. I wanted to know how they would answer it. 

In my previous 15-year career as a lender at a community bank in Arkansas, I used that question to determine just how well loan applicants understood their personal finances. If someone could quickly answer with an exact dollar and cent, then I could safely anticipate a high credit score with a successful loan payment history. It was an answer of “I’m not sure” or “a few hundred dollars” that gave me reason to pause in my decision. The purpose of the question was really about helping clients understand their personal finances. Specifically, I wanted to help them learn how to create more discretionary income that could be used to build their personal savings, which would then allow them to afford the car they really wanted in the future.  A lender should never just tell someone “No.” Rather, he or she should help the borrower understand why a “no” is necessary, as well as what they should do so they can receive a “yes” in the future. 

It is very wise to understand the three primary ways personal income can be categorized.

1. Disposable Income: the amount left over after taxes are paid 
2. Fixed Expenses: tithes, rent/mortgage, utility bills, car payments, cell phone bill, etc.
3. Discretionary Income: the amount left over after necessary bills are paid (basic food and shelter) 

Disposable income is determined by the government because tax rates are non-negotiable. But we determine our discretionary income by how we choose to manage our fixed expenses. We choose the kind of house we want to live in, the kind of car we want to drive, and the settings on the thermostat. 

If you want more discretionary income, simply limit your fixed expenses. 

Discretionary Income is defined as “the amount of money left over each month after all of the bills are paid.” It is the money we use to buy things we want such as a cup of coffee, a purse, or a new fishing pole. It is also the money we spend to do things we want such as going on a vacation, attending a concert, or taking the family out to dinner. 

People live out of their discretionary income. You may be able to afford the car payment on that new car, but will the new payment reduce your discretionary income to an amount you are not comfortable with? If you really enjoy going out to eat, a reduction in discretionary income may limit where you get to eat. Many folks have a steakhouse appetite with a dollar menu budget, which often results in credit cards being maxed out or checking accounts being over drawn. If you want to eat more steak, manage your discretionary income so that you can order one in peace.  

Too many people treat credit cards like discretionary income. Yes, credit cards can be used at your discretion, but you’re missing the point. What people do not take into consideration is the fact discretionary credit card purchases become fixed expenses with the next month’s bill. 

But let’s talk about a real issue with Christians and discretionary income. The majority of people give offerings out of discretionary income. Offerings are treated as a gift out of whatever is left over. Another great reason to limit fixed expenses is so one will have more money available to support their local church, missions, and the fatherless (see James 1:27). How much more work could be done in the kingdom if Christians would live beneath their means? 

Finally, people sometimes unwisely choose to save money out of their discretionary income as opposed to their disposable income. It is advisable to budget for savings before you decide how much to spend on a car. In other words, treat your savings as a part of your fixed expenses. 

According to a 2018 Federal Reserve Bank report, an estimated 40% of Americans do not have the ability to cover a $400 emergency with personal savings. If you fall into that category, do yourself a favor and start saving today for the rainy day that is sure to come. Take a strategic look at your income and how it is spent. Create a family budget so you can answer the question I asked at the beginning of this article with confidence. Understanding how money flows through your home will allow you to better manage how it flows. The old saying that applies to business management also applies to personal finance: “You cannot manage what you do not measure.”