the power of discretionary spending

I have to admit, I had some trouble with the title to this post. “The power of discretionary spending?” What does that even mean? Well, read on, and you’ll see. (And if you come up with a better idea for a title, feel free to leave it in the comments.)

The idea is relatively simple, almost to the point of “well, duh”: the more discretionary spending and the less mandatory spending you have in your budget, the better off you are. That is, the less money you must spend per month relative to your income, the brighter your financial outlook will be. It’s the difference between paying monthly bills and contributing towards monthly savings goals. Again, this might sound painfully obvious to the most casual observer, but I argue that while this may be so, we don’t actually prioritize it as much as we should.

What do I mean? Let me give you some examples.

You can better handle sudden emergencies. Say your car breaks down, or you have to make a trip to the emergency room, or you have to take a short-notice plane trip. The more discretionary spending you have, the better able you are to temporarily shift your spending and saving to handle this new thing. For example, you can put a little less money this month towards saving for your next car in order to repair your current one. If you’re still paying off your current car, however, you don’t have that option.

Your budget can change with your priorities. Our budget reflects our priorities; how much we spend on food, clothing, retirement, etc., reflects how much we value these things. (Or at least, it should.) And these priorities change over time — especially when starting a family! However, if you’re stuck paying mandatory bills, you don’t have the flexibility to shift your budget more towards your new priorities, like saving for a house or for college.

You can take advantage of opportunities. If you’re saving up for a new PC and it suddenly goes on sale, you can shift your budget around to take advantage of the opportunity. Oftentimes, though, people use sales as an excuse to whip out the credit card, and the interest cancels out any discount they may have gotten!

You can lower your income. In America, this is pretty much a foreign concept. Why on earth would you want to lower your income? Well, don’t tell Capitalism, but there’s more to life than spending. Having even the option of lowering your income means you can work part-time if you want more free time, or take a lower-paying job if your current one is giving you heartburn, or if you find a new one that fits your life’s passion. But if you don’t have the discretionary spending, you’re stuck.

“OK, OK,” you say. “I get the picture. But it’s not like there’s anything I can do about it.” Actually, that’s not true, if you make it a priority. Here are two very specific things you can do.

Avoid debt. When deciding whether to put something on your credit card or whether to take out a loan, consider the fact that you’re lowering your discretionary spending by doing so. If you take out a loan, you have to pay it back; it doesn’t matter if your priorities change, or your car gets totaled, or housing prices crater — you’re taking on an obligation that is very, very hard to get rid of. If you save up for the future, rather than taking on debt and paying for the past, it will go a long way towards maximizing your discretionary spending. Sometimes debt is still the right choice — but think carefully before pulling the trigger. (As a corollary: parents, start saving for your children’s college education the minute you find out your pregnant, and you’ll do wonders for their future finances. Don’t know if you’ve noticed, but student loans are eating graduates alive these days.)

Avoid investment vehicles that require mandatory spending. While the idea of “forcing yourself to save” by investing in something like a whole life or VUL insurance policy may sound appealing on the surface, the problem is that they impose heavy penalties if you change your mind. (CD’s have a similar problem, though they are of course a one-time expenditure rather than a monthly one.) I’ll go into more detail on insurance policies that also act as investments in another post, but for now simply consider the fact that they reduce your discretionary spending, which can be a huge disadvantage if you find down the line that you’re going into credit card debt in order to avoid having your VUL collapse! If you want to force yourself to save, just set up an automatic withdrawal into the appropriate account. It’s just as effective, it’s less complicated, and it lets you change your mind down the line!

So: the next time you’re making a financial decision, don’t just look at the numbers. Think about the effect it will have on your discretionary spending. Your future self will thank you!