Understanding how we spend our money is crucial to achieving financial stability and planning for the future. Two types of expenses that we encounter on a daily basis are discretionary spending and non-discretionary spending.
By differentiating between wants and needs, we can better manage our finances and prepare for retirement by tracking our overall budget and planning accordingly.
In this blog post, we will explore the differences between discretionary and non-discretionary spending and their impact on financial planning.
Discretionary Spending Vs. Non-Discretionary Expenses
Non-discretionary spending is essential to our daily lives and includes expenses such as rent, mortgage payments, and utilities. In contrast, discretionary spending includes expenses that are more optional and can be easily cut back on, such as dining out and entertainment.
|For nonessential expenses such as travel and hobbies||For expenses necessary for daily existence|
|Very flexible||Not Flexible|
|Impact on Financial Goals||Massive impact on your long-term financial goals, such as payoff debt and saving for retirement||
Less impact on your long-term financial goals
|The consequence of cutting back||Allow you to save and invest more for retirement||
You might end up leading a low quality of life
Discretionary spending is the type of spending that you can easily do without. They are not necessary to your daily existence and are often defined as nonessential spending. This means that you can easily maintain your household without them.
Types of Discretionary Expenses
These are expenses that a business or a consumer can live without. Types of discretionary expenses include:
- Travel and vacation expenses
- Tobacco and alcohol
- Automobiles and automobile-related expenses
- Coffee and other specialty beverages
- Restaurants and other entertainment-related expenses
- Hobbies and sports-related activities such as sewing, craft, and gym membership
It is important to note that note discretionary costs depend on who makes the purchase. For example, buying a car may be considered necessary for a person who must commute to work or where driving is the only option available. In the case of a company, the discretionary expenses may help attract clients and increasing profitability hence becoming a need.
Also known as mandatory spending, non-discretionary spending is the type of spending you do not have much control over. These are essential expenses you incur as a member of society, such as utilities, rent, everyday bills, and the cost of living. Expenses under this category are all needs, and you must factor them into your retirement planning.
Types of Non-Discretionary Spending
Non-discretionary spending refers to all your expenses to lead a decent life. They include:
- Living expenses: these are daily living expenses, including groceries, rent, gas, and utility bills.
- Debt: This is any credit or loan you take out, and you will need to pay down the principal balance with periodic interest. These include car loan, mortgages, and credit cards.
- Insurance and healthcare: the cost of healthcare seem to rise faster than inflation. It can be a huge expense as you age, and you must factor it into your expenses. You must account for your budget’s emergency healthcare visits and insurance payments.
- Taxes: Taxes will fluctuate as you age and shift from your salary to capital gains. Having some money to cater to the annual taxes is essential.
Budgeting Tips for Discretionary and Non-Discretionary Spending
Building your money management skills is one of the best ways to keep track of your discretionary and non-discretionary spending. The best place to start is by tracking your discretionary spending.
Here are tips to help you budget better and improve your financial management’s vital aspects.
Utilize a Money Management Tool
If you want to change your money-spending habits, awareness is where you must start. A money management tool will help you keep track of and rank discretionary expenses.
It will help you understand all your discretionary spending and a high-level view of your total monthly cost of living in relation to your income. This way, you will understand whether you spend more than you spend, allowing you to set goals to help you scale back on spending.
Break Down Your Spending by Categories
A money management tool will allow you to break down your transactions and purchases into categories. While discretionary spending is an umbrella term used to describe a wide range of expenses seen as nonessential, you may need some of the expenses to get by in life.
Viewing your expense in categories allows you to understand the discretionary expenses you would like to prioritize and the ones you need to eliminate.
Identify Expenses to Cut Back On
To save and invest more for retirement, you must identify the expenses you must cut back on. While tracking your expenses, you might realize that you may need to cut back on eating out or take-out dining to save more.
Place Discretionary Funds in a Separate Account
Suppose you often find that your discretionary budget often goes above your budget, taking money away from necessary expenses. In that case, you might want to put away money for your discretionary spending in a separate bank account.
You can pay your bills through one bank account and place your flexible spending in another account to ensure you do not exceed your monthly budget. Consider getting a debit card for this account rather than building up credit card debt.
Prioritizing Your Spending
One way to take off the stress of budgeting is using the 50-20-30 rules. This way, you do not have to get overwhelmed by having a budget for every category, such as clothing or entertainment.
The 50-20-30 rules allow you to budget your income in the budget categories, which include:
- Living expenses: This takes up 50% of your income, including essentials you must pay monthly, such as transportation, rent, and food.
- Saving and investment: This will take 20% of your budget. This is your money towards your financial goals, such as retirement or emergency fund account.
- Discretionary spending: The remaining 30% is used on anything you want. It covers all the non-necessities such as travel and entertainment.
Case Study: John’s Budgeting Journey
Problem: John, a 30-year-old professional and business owner, struggled to manage his finances and save for retirement.
Solution: John implemented a budget and tracked his expenses to gain better control over his finances.
- Calculated his monthly income by dividing his previous year’s income by 12
- Implemented the 50-20-30 rule to manage his income
- Tracked every coin he spent on non-discretionary and discretionary expenses, as well as his savings and investments
- Identified areas where he could cut back on expenses, such as dining out and transportation
- Made more informed decisions about his business and personal life based on his financial situation
- Gained better control over his finances
- Increased his savings and investments towards his retirement goals
- Made more informed decisions about his business and personal life
Table: John’s Monthly Budget
|Savings and Investments||$1,200||
Note: The percentages in the table correspond to the 50-20-30 rule that John implemented, which suggests allocating 50% of income to non-discretionary expenses, 30% to discretionary expenses, and 20% to savings and investments.
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Tracking your discretionary and non-discretionary spending allow you to plan for your future finances. Understanding your living expenses lets you know how much you need to set aside for retirement. Your spending determines how much you will need to save and invest for the future.
- Discretionary spending refers to unnecessary spending such as hobbies, travel, and vacation.
- Non-discretionary spending is also called mandatory spending, which includes your daily living expenses such as rent and food.
- Use the 50-20-30 rule to budget and track your monthly spending while allowing you to save money or reach your financial goals.
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