The term discretionary means – “for any use or purpose one chooses”. Therefore, a person’s discretionary income is the portion of their earnings that is not earmarked for any specific purpose. Another way to think about discretionary income is the amount of money that is leftover after all essential items (and taxes) have been paid. Essential items could include food, shelter, and clothing, among other expenses.
For many people, discretionary income is used to buy luxury items, pay for vacations, and purchase any non-essential item or service. The definition of a non-essential good or service differs from person to person. While shelter can be considered a necessary expense, purchasing a larger home than your family needs could be considered a luxury and not a necessity. Food is also considered a necessity but going out to eat every night is more of a luxury.
The bottom line is that each purchase a person makes could be debated if it was done so with discretionary funds or not. The more discretionary income a person has at their disposal, the more leverage they will have in becoming financially independent.
Discretionary Spending Versus Personal Debt
Many economists believe that discretionary spending is important for a healthy economy. When times are good, there is more money available to be spent on non-essential goods and services like travel, luxury cars, and the latest electronics. All this extra spending leads to high corporate profits and a bullish stock market.
There is no doubt that the more money being spent will lead to higher corporate profits and a healthier economy. This is fine as long as these non-essential items are being purchased with leftover income. The problem comes in when luxury items are being purchased by using credit cards and other forms of debt.
When ones discretionary income runs out, any purchase on non-essential goods or services is probably funded through debt. Using credit cards, home equity loans, and other forms of debt on luxury items is different than having discretionary income.
Increase Your Discretionary Income
An important part of becoming financially independent is to increase ones discretionary income whenever possible. This can be done by adding extra income sources to your active income (money earned from your job) or by taking a higher paying job or position. Even if you are stuck in a dead end job, you can still add alternative forms of income to your earnings.
Another option to increase your discretionary income is to simply spend less than you earn. No matter how money you make, living above your means will eventually catch up with you. There are numerous ways to save money in and around your home. Look at cutting down on expenses in and around your home first, such as your utility costs. Every little bit adds up and over time you will learn how to cut even more from your budget.
One of the ways I like to increase my discretionary income is through the purchase of other assets. For example, investing in dividend paying stocks is one way to generate more income. This would actually be considered a non-essential expense, as owning stock is not critical. However, by investing in other assets that produce income you are actually accelerating the process.
Final Thoughts
Becoming financial independent requires one to build up as much discretionary income as they possibly can. This can be done from a variety of methods including spending less on essential items, adding additional income streams to your earnings, or investing money into assets that produce more income.
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