Discretionary or non Discretionary an Important Distinction for Personal Financial Planning

Discretion implies choice. There are some things in life that you can choose to do, and others that must be done out of necessity or compulsion. Having a roof over one’s head and enough food to eat is a necessity. Paying income taxes is compulsory. Taxes and the basic essentials of life are non-discretionary spending: there is no choice involved. Every other type of personal spending is discretionary.

Types of non-discretionary spending

Food and shelter have been the two most basic needs since man’s earliest ancestors first trod the earth. They were the driving force behind the formation of civilized societies, the expansion of economies and the waging of wars, and they still occupy the premier positions in the non-discretionary spending ladder in the 21st century.

In the developed world, at least, a few others have joined the list. They are essential clothing, adequate sanitation, an energy source to cook food and provide light at night, health care, heating in cool climates, and transport to and from work or school. Someone living on an income which covers only these fundamental requirements is unlikely to be paying income tax, but if tax is added to the list, all truly non-discretionary expenses have been covered.

Where to draw the line between discretionary and non-discretionary spending

What is classified as non-discretionary spending in the developed world may well seem like an unattainable luxury to millions of people in developing countries who lack basic foodstuffs, sanitation and shelter. So the point at which the line is drawn between non-discretionary and discretionary can be a subjective decision to some extent. Classifying one item as essential inevitably attracts related expenses which will fall into the same category.

For example, a home owner may regard property maintenance and insurance as non-discretionary expenses. Someone addicted to nicotine may be unable to forego cigarettes, and thus classify their purchase and consumption as non-discretionary. Perhaps the best way to arrive at a definition for your own case is to list your expenses in order, starting with items you could not possibly survive without and gradually progressing to those you would prefer to have. Draw the line just above the first ‘prefer to have’ entry.

Guide to average amounts of discretionary and non-discretionary spending

The US Bureau of Labor Statistics publishes an annual survey of consumer expenditures. In 2011, the latest available data is for the year 2009. This is a convenient list of the types and amounts of expenses faced by the average household, as well as a useful tool for comparing your personal or household expenditure with the US average. The opening remark is significant: ‘Consumer units spent 2.8 percent less, on average, in 2009 than in the previous year. This drop in spending—from $50,486 in 2008 to $49,067 in 2009,  in nominal dollars — marked the first time a year-to-year decrease has been measured by the Bureau of Labor Statistics (BLS) Consumer Expenditure Survey (CE) since the CE began publishing integrated data in 1984’.

While ‘Food at home’ dropped 0.2%, ‘Food away from home’, which is discretionary spending, fell by 2.9% in 2009. Other significant discretionary expenditure falls were seen in alcoholic beverages (down 2%), household furnishings and equipment (-7.3%), entertainment (-5%) and personal care products (-3.2%). Transportation and tobacco costs are affected by taxes and excise, so it is difficult to draw any conclusions from the changes in those items. Overall, it seems probable that the global financial crisis had a downward impact on discretionary spending in the US in 2009. 

Importance of distinguishing between discretionary and non-discretionary when budgeting

If you have a personal or household financial budget, which is a helpful tool for everyone, and an essential for anyone on a limited income, you will need to be able distinguish between discretionary and non-discretionary expenses. The reason for this is that the discretionary expenses are the ones that give you a certain amount of wriggle room if your budget does not balance, whereas non-discretionary expenses are by their very nature unavoidable.

The best way to set up your budget is to work out your net annual or monthly income, after deductions such as income tax and any other items deducted from your salary before you receive it. Then list your non-discretionary expenses such as rent or mortgage repayments, basic food costs, utilities, health care, reasonable clothing requirements and any necessary transport or vehicle running costs. Deduct the sum of the non-discretionary expenses from your net income. If you are fortunate this discretionary income margin will be a positive number, which now allows you to list some discretionary expenses, such as phone and internet costs, entertainment, eating out, fashionable clothing, a vacation, and new appliances or electronics. Going into debt to buy such items is not the same thing as having discretionary income. Mortgage lenders may be very interested in the amount of your discretionary income when assessing your viability for a loan.

Everyone’s list of discretionary expenses will be different, but the aim is still to have at least a balanced budget, and preferably a slight surplus to add to your rainy day savings. Deduct the total of your discretionary expenses from the discretionary income margin that was left after non-discretionary expenses were subtracted from your income. If the number is negative you will need to trim some of your discretionary expenses until your budget balances. Having to reduce discretionary expenses, whilst disagreeable, is not as painful as being unable to meet non-discretionary expenses. Making sure that you understand the difference is an important part of being in control of your finances.