Disposable Income: What Is it and How Does it Affect your Finances?
The term “disposable income” is something of a misnomer. It sounds like fun money, but it’s quite the opposite. Also known as disposable personal income (DPI) or “take-home pay,” disposable income, is the amount of money available after taxes and other employee deductions have been taken out of your paycheck. It’s not truly “disposable” because it has to cover your family’s most essential needs each month.
So why is disposable income so important? On a national level, it’s used to measure consumer spending and the health of the economy. On a personal level, it’s often a critical factor in determining your family’s financial resources.
Let’s take a closer look at disposable income to learn more about what it is, what it isn’t, and how to use it as the basis for your household budget.
Disposable Vs. Discretionary Income
Disposable income is the money you have left over after taxes to pay for necessities such as rent or mortgage, transportation, groceries, utilities, insurance premiums, and other essential costs.
Discretionary income, a subset of disposable income, is the amount of money you have left over after you’ve paid for all the above necessities. It’s up to you to how to use your discretionary income—you can save it, spend it, invest it, or some combination of the three.
According to freelance writer and ThoughtCo contributor Robert Longley, disposable income and discretionary income are two of the most important terms in the world of personal finance. “Understanding what disposable income and discretionary income are and how they differ is the key to creating and living comfortably within a manageable budget,” he explains.
Budgeting your Disposable Income
There are many different budgeting methods out there, and the one that’s best for you and your household might be quite different from that of a friend or family member. However, many experts agree that the 50/30/20 method is a great option for new budgeters, as well as those who don’t necessarily want to get into the nitty-gritty of tracking spending via multiple categories.
With the 50/30/20 method, you only have to manage three broad spending categories:
- 50 percent of your income is set aside for needs (e.g. housing, groceries, utilities, health insurance)
- 30 percent of your income is set aside for wants (e.g., dining out, travel, movies)
- 20 percent of your income is set aside for financial goals, including savings, investments, and paying down debts such as monthly credit card bills
To see how your current spending compares to the 50/30/20 budget, you can do the calculations yourself, or use one of the many free budget worksheets available online.
Making the Most of Your Disposable Income
If your needs fall within 50 percent of your disposable income, congratulations! You’ve already mastered the hardest part. If not, you may be living beyond your means, which could indicate that you need to make some adjustments, either by spending less or earning more.
You can also take a closer look at your recent bills to see if you’ve neglected to factor in certain commonly forgotten expenses, such as car registrations, organization dues, pet care, haircuts, and gifts. The more aware you are of where your money goes, the more success you’ll have when it comes to saving your discretionary income for big-ticket items like family vacations.
Understanding what disposable income is and how it works is really the first step in creating and maintaining a healthy household budget. If you follow the basic parameters of the 50/30/20 budgeting method and make adjustments where needed, you’ll be better prepared for any unexpected expenses that may arise—and more likely to enjoy a stress-free financial future.