Money for funding international trips, spending on the latest smartphone, or even enjoying a gourmet meal at the best restaurant comes out of extra funds left after meeting our essential expenses. This surplus fund pool is called discretionary income. As the name suggests, you can use these funds at your discretion - either opting for investment options or spending them on lifestyle improvements. But before you decide what to do with these funds, it is important to thoroughly understand what is discretionary income, its impact, and its importance.
What is a discretionary income
Discretionary income is the amount of money you have left after paying taxes and spending on essential requirements like food, rent, or paying electricity bills. In other words, it is the amount of income you have left to spend, save, or invest after deducting essential financial obligations from your total income. Discretionary income is generally used purchasing non-essential items, booking holidays, dining out, or buying luxury goods. You can also use it to ensure goal-based savings, like building up a contingency fund or saving for the down payment on a house. The ‘discretionary’ tag suggests that this income can be used as per your requirements. You can allocate these funds according to your personal needs, goals, and financial strategies.
Analysing discretionary income
Knowing the meaning of discretionary income is not enough; you also need to understand how the concept can help streamline your personal finance strategy. Evaluating how much money you have left after mandatory expenses are covered helps ensure effective budgeting and prudent financial planning. Creating a budget typically involves listing your income and expenses and then drafting a spending/saving plan around your discretionary income. Tracking your discretionary income usage can help identify excessive outflows on non-essential items, exposing potential savings avenues.
The increased savings can be used in alignment with your long-term financial goals, like building a house fund or retirement planning. You can invest these funds accordingly in various investment vehicles like the POMIS scheme, mutual funds, stocks, and FDs.
Difference between disposable income and discretionary income
People often use discretionary income and disposable income interchangeably in common parlance. While the two are very similar concepts, they actually apply to different income types. Disposable income is the amount of money you have left after paying direct taxes. In simple terms, it is the take-home pay or net income you receive, which can be used to meet essential and non-essential expenses.
Discretionary income is the residual income left from your disposable income after essential payments for rent, utilities, food, transportation, mortgage, insurance, and others. Discretionary income is the money you have left after paying taxes and covering your basic needs. It shows how much you can use for spending, saving, or investing.
Economy and discretionary income
Discretionary income is not just an essential metric of personal finance but is equally crucial in gauging the health of the general economy. When consumers have high levels of discretionary income, they tend to spend more on non-essential goods. This results in improved demand across sectors, boosting business revenues and encouraging expansion and job creation. Alternatively, when discretionary income reduces, consumer spending on non-essentials contracts, slowing down the economic momentum. In simple terms, aggregate discretionary income rates tend to fluctuate over time with the changing business cycles of the economy.
Similarly, during inflation, when prices of consumer good rise, discretionary income falls (assuming taxes and wages remain the same. Additionally, discretionary income falls due to wage and job cuts during periods of recession. Given the low levels of discretionary spending, companies selling discretionary items like electronics, luxury items, etc., struggle to survive during such economic downturns.
This concept is used alongside disposable income to compute other essential financial ratios like marginal consumption propensity (MPC) and marginal savings propensity (MSP). Economists use these important indicators to understand changes in expenditure and saving trends with income changes.
Conclusion
While discretionary income can be used to improve your lifestyle with non-essential spends, it can also help make prudent investments and ensure long-term financial health. Understanding the meaning of discretionary income helps you better manage your personal finances. When this income rises due to a promotion, you can leverage the increased income to ensure future financial stability. For instance, you can invest in the Bajaj Finance FD, which offers interest rate of up to 8.65% p.a. With high yields and complete capital protection, you can secure inflation-beating returns and safeguard your purchasing power against future inflationary pressures.
