Discretionary income is one of the most important things in determining how we live our lives. People often get this term confused with disposable income, which is basically just another term for net income, or your bring home pay after taxes. But discretionary income is something that is so important for us as individuals that on a macro level it determines the overall economy.

What is Discretionary Income?

Discretionary income is income left over after you pay taxes and living expenses. In other words, take your disposable income (net income) and subtract all of your mandatory bills, whatever is left is your discretionary income.

Mandatory bills include your housing expenses, utilities, food, transportation, medical expenses, loans you are paying back, and anything else you’re obligated to pay monthly.

That’s the main thing here. Whatever you’re left with after the bills you have no choice in paying, then that is your discretionary income.

Things that wouldn’t be included in factoring your discretionary income would be things you choose to pay each month. This would include entertainment, clothes, vacations, etc.

Discretionary spending vs Non-Discretionary Spending

Another way to think of this is that your discretionary income is essentially what you can choose to spend your money on, therefore it is discretionary spending.

If you’re income is $3,000 per month and your mandatory bills total $2,000 per month, then you have $1,000 to spend on whatever you want each month. Therefore you can spend that $1,000 at your discretion.

The $2,000 that you’re forced to pay each month would be your non-discretionary expenses.

Now, this would include things like food and gas. You have to eat, and you likely have to drive to work etc. Of course if you don’t have to spend money on these things they wouldn’t necessarily be included.

So in other words, gas to and from going to see a rock concert an hour away isn’t a necessity, it’s an extra expense that you chose to spend, but gas you use to fill up your vehicle to go to and from work would be considered necessary.

Overall, you’ll have a general area of food/gas that you spend each month although it can fluctuate based on your choices and the overall economy. Which brings up.

Discretionary Income Determines the Overall Economy

For rather obvious reasons, discretionary income plays a big role into calculating various macro economic ratios used to determine overall economic health.

A couple of these economic ratios would be the marginal propensity to consume and the marginal propensity to save. In a general sense, discretionary income determines how healthy the overall economy is because it’s going to determine how people are spending money.

This is pretty obvious after understanding the definition of discretionary income.

What is the Average Discretionary Income in the United States?

This is going to take so many different factors in that we can’t really get an exact answer. But if we look at the mean over 3 years from 2018 to 2020 then what I found was this:

The average household expenditure was $5,155 and the average gross income was $6,829. Meaning we’re all broke and have no discretionary income…yikes.

I know what you’re thinking…$6,829 minus $5,155 equals $1,674. Yeah, but that’s from gross income!! So if you use the average net income then that means there’s basically nothing left. Gross.

Now, of course this is the mean, which means it is going to be skewed by high earners, and even though high earners have more household expenditures, they also have more discretionary income regardless of that.

If we’re examining middle to lower class households then that the number is even more depressing. Granted, most lower to middle class earners don’t pay any federal taxes so the gap between gross pay and net pay may not be as drastic.

And of course, discretionary income not only varies by income, but it’s also going to very quite a bit by household size. For example, according to BLS data, the average expenditures of a single person household are just above 38k while a 5+-person household averages about 81k.

All of this is going to lead to drastically different outcomes, but the overall answer to this is that the average American has basically no discretionary income whatsoever.

We tend to spend everything we make, and this is a huge problem if you’re trying to build wealth. It’s simply a mathematical problem. If you aren’t making more than you earn, you’re never going to be wealthy.

You either need to make more money or reduce your bills to increase discretionary income.

How to Calculate Discretionary Income

To reiterate, calculating discretionary income means that you’re taking your net pay and subtracting necessary bills and expenses.

A list of things that would be included in necessary spending would be:

Housing and utilities
Vehicles and Insurance
Credit cards
Phone, internet
Childcare
Personal loans
Student loans
Medical bills
Food and gas

And here are some items that may or may not be considered depending on the exact definition of discretionary income:

Gym memberships
Streaming services (Netflix, Hulu, etc.)
Cable
Entertainment

Personally, when I’m calculating my discretionary income I include the bottom items as well with the personal budget I use. Technically these aren’t necessary, however, if they are bills you spend money on then I think these should be included.

We’re human beings, not robots, and it’s inevitable we are going to spend some money on at least some of these things. Or at the very least there is going to be a general number that we consistently fall under.

Of course, when trying to increase your discretionary income, these would be an area we could likely increase our discretionary income by reducing some of these expenses.

What Discretionary Income Means for You

Having discretionary income really is a key indicator on how well off financially you are. Granted, you very well still could have a high net worth while being completely maxed out on your bills.

If that’s the case then maybe you could consider selling assets to decrease debt. Or maybe you don’t mind pushing the limit. That’s entirely subjective.

However, having discretionary income doesn’t mean you only have income to piss away on dumb things. This is income that you could also be investing with.

Think about it like this, the more discretionary income you have the more opportunity you have. Sure, you can go have fun with it, but it also gives you the opportunity to dollar cost average into investments to create wealth.

Or, it gives you the opportunity to save money to invest in a business opportunity. The more discretionary income you have, the more opportunities you have to make extra money.

So it’s not just about putting money in the bank, it’s about creating opportunities for yourself and not being financially strapped.

If you’re completely maxed out on your bills each and every month. This could be creating a situation where your forced to work a job you really don’t want to do.

Or it could be creating a life where you’re going to be stuck working until the day you die because you can’t create enough money to live off of without working.

Discretionary income should be something that you consider before making any big purchases or before investing in assets or business opportunities.

This will be one of the main driving forces of everything you do in modern day society.

Conclusion, What is Your Discretionary Income?

What is your discretionary income? The numbers show that the average American basically has very little discretionary income. Is yours almost nothing like the average American, or do you have a little bit of leeway on your spending? Is there anything you’re currently doing to increase your discretionary income?

The fact of the matter is that if you’re tracking your finances then discretionary income should really be towards the top of the list. It is going to dictate so many aspects of your life. The bottom line is that you either need to increase your income or reduce your obligations to increase discretionary income.