The act of spending can elicit a wide array of emotions: some positive, some negative. Finally pulling the trigger on an item you’ve had your eye on for weeks can be an extremely gratifying experience, while having to unexpectedly replace an appliance or pay for an auto repair is generally not a fun time. Each of these may have the same effect on your wallet, but make for a much different afternoon. This is an illustration of the distinction between discretionary and non-discretionary spending, and a better understanding of how you handle each can help put you on the fast-track to improved financial health.
Non-Discretionary Spending
Let’s cut to the chase here: for most of us, the majority of our non-discretionary spending in any given period can be summed up in one low-down, dirty word: bills. While these bills may vary in size, quantity, and frequency, the fact of the matter is that paying our bills is what enables us to have a place to live, utilities, insurance, transportation, and countless other necessities. By definition, non-discretionary means: not subject to or influenced by someone’s discretion, judgment, or preference. You may be saying to yourself “I have control over where every single dollar is spent!” While this is certainly true, as relates to your personal finances there will almost ALWAYS be a certain amount of expense that you must spend in order to live.
As I said mentioned before, the size, quantity, and frequency of our non-discretionary spending items may vary, but generally include the following categories:
- Taxes: all taxes are generally withheld from W2 income, but should be factored into any other income you receive; as Benjamin Franklin said: “nothing is certain in this world, except death and taxes”
- Housing: payments toward a mortgage or rent that are usually fixed.
- Transportation: expenses associated with auto or public transport
- Insurance: costs associated with health insurance premiums, other medical insurance, auto insurance, and homeowner/renter insurance
- Utilities: electricity, water, garbage, gas/heating costs
- Groceries: food costs (NOT to be confused with eating out, more on this later…); this should also include various household items needed: cleaning and bathroom supplies, tools, etc.
- Health/Medical: any recurring expenses associated with a medical condition
- Communication: the days of landlines are behind us, be we all generally need a means of communication
- Buffer/Miscellaneous: estimate for unplanned necessities and will tie into your personal emergency fund
The last item on this list that should coincide with everyone’s non-discretionary spending that cannot be overlooked is a buffer or miscellaneous category. Most of us can relate to the fact that, especially in our auto, medical, or housing expenses, that there almost ALWAYS tends to be an unexpected bill or expense that blindsides us. For this reason, it is extremely important to add a cushion to your monthly non-discretionary expense budget. I would strongly recommend at least an additional 5-10% of your total non-discretionary expenses; for example if your total budget each month for these categories arrives at $3,000, then plan on an additional $150-$300 per month in unplanned costs.
Arriving at an appropriate total for each of these categories can take a bit of time, but will be very valuable in understanding what your base living costs are. In my experience many individuals and families vastly underestimate their base expenses, which can result in a very wide gap in the amount of money they plan to save and what they actually do. We will spend more time exploring ways in which each of these areas can be reduced, but your first objective should be a solid understanding of just how much you are spending on each currently.
Your “Fun Money” – Discretionary Spending
As you may have already guessed, discretionary spending is essentially all the money spent on the non-discretionary items during a given period. This term is effectively interchangeable with “discretionary income”, which refers to the amount of income leftover after all non-discretionary expenses are paid. It may go without saying, but the major categories of discretionary spending for most of us tend to be:
- Restaurants/Eating Out: the largest and most enjoyable discretionary spending item, at least for my household.
- Clothing/Beauty Items: covers all expenses specific to purchasing clothing and most other beauty and personal items
- Recreation & Entertainment: all costs in conjunction with our activities and hobbies; should also include entertainment costs (think cable, internet, Netflix, Hulu, etc.)
- Home/Living: expenses associated with household goods purchased outside of necessities (think decorating, yard maintenance, cleaning services, etc.)
- Travel: all expenses associated with planned travel; perhaps the most variable of discretionary spending items
- Buffer/Miscellaneous: in keeping with the theme of creating a bit of “cushion” when budgeting, I recommend doing so in your discretionary spending as well; take a good look at your spending habits and tendencies before deciding on how much is right for you and your family
This list of categories has helped me tremendously in grouping expense together for my personal budget, but can obviously be changed to more closely fit your own personal situation. The main objective is the same: accurately split expenses between “need” and “want” items which are very important in evaluating your financial health. Before you start feeling the walls closing in around you from information overload, let’s take a look at a couple of visual examples of how this should look.
Household Expense Budget – Examples
The $-amounts in these samples are fictitious, but can easily changed to reflect your specific circumstances. It’s easy to see that while each of these budgets results in the same monthly spending total, where each dollar is spent varies quite significantly. The Adams family chooses to spend a large portion of their income on restaurants and travel, while the Brady bunch has nearly $1,000 more in non-discretionary expenses. This makes the perfect segue into our next topic:
“Good” vs. “Bad” Expenses?
This topic is the epitome of a slippery slope, and hours could be spent dissecting the merits of each dollar we spend. However, there is an overall idea to keep in mind here: not all expenses are created equally, and some of your costs are more helpful and valuable to you than others.
To illustrate this, let’s compare and contrast the housing costs of the sample budgets from earlier in the post:
- Brady bunch monthly mortgage expense = $1,500
- Adams family monthly rent expense = $1,000
While the Brady bunch spends $500 more per month on their mortgage, the Adams family spends $1,000 per month renting. While the Adams family may be spending less money on housing in total, we can’t forget that a portion of the $1,500 spent by the Brady bunch is building equity in their house, which increases their total net worth. Another important distinction is the tax deduction benefit that the Brady bunch receives from paying interest on their mortgage balance as well as their property taxes.
This is a fairly obvious example, but helps to prove that not all expenses should be treated the same way. Keep an eye out for more posts on debt management, and which expenses to try and avoid in the future.
Knowing Where You Stand
In keeping with the theme of Budgeting 101, taking the first step in improving your spending habits requires a good understanding of exactly where and how much you are spending on a regular basis. I encourage you to use whatever method of tracking is most convenient for you, and there are a variety of free tools and software available to do so (just to name a few):
- Software: Microsoft Excel, Microsoft Money, QuickBooks
- Online Tools/Apps: Personal Capital, You Need A Budget (YNAB), Mint, BudgetPulse
However you choose to get there, take the first step towards improving your spending habits by getting familiar with you discretionary and non-discretionary expenses. Once you’re armed with the facts needed, you can start to make a conscious effort to improve your financial fitness.
Make sure and comment below with any ideas, advice, or experience you have on the topics mentioned here!