What is Discretionary Income?
Discretionary income is the income left over after paying taxes and normal living expenses.
How to calculate Discretionary Income
Discretionary income is the income remaining after the essentials (taxes, food, clothing, shelter, etc.) have been paid for. Discretionary income is often confused with disposable income -- disposable income is income available after paying taxes. For example:
Gross wages: $90,000
Disposable Income: $70,000
Car Payment: (5,000)
Discretionary Income: $25,000
The disposable income in this example would be $70,000 (or gross wages of $90,000 less the taxes of $20,000).
The discretionary income in this example would be $25,000 (or disposable income of $70,000 less all the necessary and basic living expenses of an individual or family). It is the amount remaining that can be used for non essential purchases, investing, and/or saving.
Why does Discretionary Income matter?
The concept of discretionary income is important on both a micro level and a macro level
When an individual applies for a loan, the bank often considers the applicant's discretionary income level. The loan will most likely be repaid out of discretionary income.
In the U.S. economy, powered largely by consumer spending, discretionary income is endlessly tracked, analysed and discussed. In a recession, discretionary spending dries up, and businesses who sell necessities tend to perform better than those that sell luxuries. In a recovery, the relationship is reversed.
It's possible for investors to take advantage of these economic cycles. If you want to learn more, click here for our must-read article on sector rotation, Rotate Into the Best Stocks to Buy Now.