This has been a big week: I had dinner with my biological sister, whom I haven’t seen in 7 years. (I was adopted.)
But this isn’t a blog post about cross-country family reunions. It’s a post about a magical thing called discretionary income, the key to a portal of incredible opportunities.
Discretionary money lets me visit my family in any corner of the globe without blinking an eye.
Wealth is measured by discretionary income, not raw income. A person who earns $8,000 per month but “needs” $8,001 to pay her self-imposed bills is in a worse financial position than the person who earns $2,500 but needs only $1,500.
Based on this Afford Anything definition of wealth, most people are poor, even those with six-figure salaries. Most people abuse credit cards and car loans and insane mortgages, trapping themselves in huge obligation loads and forcing their cost-of-living to spiral beyond control.
Then when an opportunity of a lifetime leaps in front of their eyes, they’re forced to quietly say no. They become their own jailers.
You don’t need a million dollars to be wealthy. You simply need to reduce your necessities so that you have gallons of discretionary money.
Amplifying Your Discretionary Income
Beyond a certain bare-minimum baseline of needed spending, everything else is discretionary. And you might be shocked to find how little money you truly “need.”
That baseline, I believe, is about $12,000 annually for a single person living in the U.S., or about $1,000 per month. That’s the least amount of money that a person can comfortably live on (though I’m sure there are stories of people living on less.)
During my college years, I lived on $1,000 per month, which consisted of:
$400 – Rent, including all utilities
$200 – Groceries
$100 – Health insurance
$50 – Basic cellular phone (NOT smartphone)
$250 – Miscellaneous everything else (toothpaste, sunblock, thrift-store clothes)
I didn’t own a car, home, or pets. I didn’t get fancy haircuts or drink lattes.
Did I want these things? Absolutely! I missed the company of pets. I wanted a better haircut. I wanted to live in a higher-cost-of-living area, like San Francisco (near my sister) or New York.
But I knew that these are discretionary choices, and I chose not to partake in them.
You can afford anything, but not everything. Every $1 is a trade-off.
Every $1 that I spent on gasoline or property taxes or an overpriced haircut would be $1 less that I could spend on my lifelong dream, world travel. After a few years of this lifestyle, I had saved enough to quit my 9-to-5 and jet around the globe.
Most people would say that owning a car, home, smartphone and new clothes are “necessities.” I believe they hold limiting beliefs.
You can increase your options in life by radically redefining “necessity.”
You Can Live on Less Than You Think
Do I maintain that ultra-bare-bones lifestyle today? Nope. These days I own a house, dine at sushi restaurants, get my hair highlighted, subscribe to Netflix, live with two cats and belong to a yoga studio.
I also recognize that these are choices, and I’m willing to accept those trade-offs.
Most people think of this as “normal” or, worse yet, conceptualize these expenses as “necessities.” But face the facts: this is ALL discretionary spending, every last dime of it.
Clothes? Discretionary. Cat food? Discretionary. Cell phone? Discretionary.
There’s nothing wrong with consciously choosing to spend your money in this manner (assuming you’re maxing out your retirement accounts and you have no consumer debt). But you MUST recognize it for what it is: luxurious discretionary spending, which comes at the cost of making trade-offs against other alternatives.
The vast majority of us spend most of our money on discretionary purchases. We just don’t realize that those purchases are discretionary. We’ve come to think of them as “normal.”
They’re not normal. They’re luxuries. Yes, everyone else is spending their money in that manner, but everyone else is broke.
To maximize your discretionary income, thereby living like you’re rich, reject the purchases that are “normal.” Shift your money towards the purchases that you truly want. Radically redefine “necessity.” You can live on less than you think.
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Wealth is totally measured by discretionary income. I agree wholeheartedly. And I was thinking about the same dichotomy of my college days vs. now just the other day. I used to live SO cheaply. I used to couchsurf. Now I pay for a place to stay when I travel (usually AirBnb). Things change as we grow up. I’m ok with using a bit more of my discretionary income on luxury items like craft beer. But I always want to keep that big gap between what I bring in and what goes out every month. It provides such wonderful flexibility. Thanks for the post Paula!
I have the same experience, Joel … I used to live SO cheaply, always couchsurfing/camping/sleeping in the back of cars while I traveled. Now I also use AirBnb. 🙂 And I’m totally okay with that. 🙂
We live in a consumer based society. The notion of wanting and having things is ingrained in our culture. Those of us who are wise to what “discretionary spending” is all about are able to live accordingly and usually come out on top in the long run. “Keeping up with the Joneses” will, unfortunately, always exist.
Wow, I can’t even tell you how much I love this post! You put into words what I have been thinking for a long time. As soon as I realized my financial goals a few years ago, it became easy to cut spending on those “normal” (i.e. luxury) items because I knew that I wanted the money to be used elsewhere! I wish everyone would sit down and figure out their financial priorities- I bet there would be a whole lot less debt and a whole lot more happy people! Thank you for the awesome post!
Ashley — I’m glad that this resonates with you! I think that the difference between “necessities” and “discretionary” can be super-noticeable when you’re in your twenties. I had to live VERY cheaply during college, due to sheer necessity. I saw just how little money I could live on. And by “maintaining” that student lifestyle for a few years after college, I amassed tens of thousands that I could spend on my top priority, travel.
I think you’re right … if more people realized this, the world would have a lot less debt and a lot more free, happy people! 🙂
This would require that people living in expensive areas of the country move – even if that would mean moving away from family, friends, roots of a lifetime or even of generations. It also does not account for the fact that if they were to move, their life would likely cost more than the “locals” precisely because they don’t have those connections.
Also, there are values questions in there: I’d give up traveling forever to have cats! I would not give up animals except VERY temporarily to have more travel.
Precisely, Barbara — it’s all about values. The heart of money management is a conversation about values and priorities, and that’s why I disagree with the writers who issue one-size-fits-all dictums.
For some people, pets are a major priority, and they’d gladly reduce their traveling (or increase their hours working) in order to have a pet. For others, however, cutting back on hours at work is a bigger priority than having pets. Neither is “right” or “wrong” — the choice is a reflection of your personal values and priorities. The bottom line: It’s a CHOICE, not a necessity.
Yes, living in expensive areas is a choice. Moving to a cheaper area is a choice. Visiting your friends/family back home is a choice. Many immigrant families, including mine, spend decades without seeing their extended family back in their homeland. That’s often because of the stark tradeoffs involved (we could save for retirement, or we could fly home to attend a cousin’s wedding, but not both). That’s a choice.
Hi Paula! I love your site and your writing style; you are a joy to read! What are your thoughts on jobs that “require” a car? I currently work for a company in the Boston area that involves driving to different locations, most of which are not accessible via public transportation.
Also, the cheapest rent in my area is about $800 to $1000 per month, utilities not included. Is a roommate my only option??
@Dave — Would you have a car if your job didn’t require one?
If your answer is “yes, I would own a car,” then you’re only spending wear-and-tear/gasoline/repairs for your job-related use.
But if the answer is “no, the ONLY reason I own this car is for my job” — then every penny associated with that car is a job-related expense. If you earn $50,000 a year and spend $5,000 annually on a car that you otherwise wouldn’t own, then you “really” earn $45,000 (minus other costs associated with working, like buying business clothes, dry-cleaning, etc.)
If you were an entrepreneur, buying a car for the exclusive use of your own business, you’d be allowed to write-off the expense, since it genuinely does diminish your profits. Conceptually, employees who own a car exclusively for work-related reasons also see their profits diminished (though without the tax break).
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As for rent: Getting a roommate is one option. (I recommend it because it’s a “big win.” You can save $500 in one simple shot, rather than trying to save $50 X 10 times.) But if you really don’t want a roommate, your two alternatives are to majorly cut back in other areas of your life, or to increase your working hours. Among those three choices (get roommate, earn more, spend less), which appeals to you most?
I have always lived on less and managed to save and invest. I did very well with my investments to achieve financial independence in my late thirties. I did not sacrifice everything and made cetain thins like savings a priority.
I think we can absolutely live on less than we think. The list of “bare necessities” is really quite short when you get down to it. But for me, committing to owning a cat means cat food = necessity, not discretionary. Though it doesn’t mean it has to cost a fortune. =)
Ah, but the initial commitment is a choice. No one forces us to adopt cats or dogs. Once we accept that responsibility, though … well, then it’s a responsibility. (I’m a cat person, too, but I refrained for years when I was in my mega-savings stage.)
Now that I have two cats, I have a 15+ year financial responsibility … which I chose to enter of my own free will. 🙂
In expensive areas people pay more and expect less. Gas is $4.35 here, a gallon of milk can top $6, it crimps on discretionary income. Due to high land prices and housing I have seen houses here subdivided into three or four units with no kitchen, just sinks and microwaves. Priced well they get rented immediately.
I broke every rule of real estate when I bought the largest house on the block at the highest price for the neighborhood. Our house is two stories, we rent downstairs out that has a separate entrance. There is a staircase inside the house that links the house, we have a door that is always locked. We have complete privacy, I never hear my renters. The rental income I receive covers more than half of my mortgage and housing costs. Had I bought a smaller stand alone house for $150,000 less my housing costs would have nearly doubled as I would not have this rental. Only in an expensive state would people pay a high rent for the bottom floor of a house.
@Charles — You made a very smart decision. As I’m sure you know, I’m a HUGE fan of generating rental income to supplement your mortgage pay-down, to pay off your mortgage entirely (giving you a ‘free’ house), and to generate passive income. Just think: once your mortgage is paid off, all of the net rental income that you’re getting from the downstairs unit will be yours to keep. That’s a wise, wise money move … it’s much better than arbitrarily buying a “cheaper” house that would yank more dollars out of your pocket.
HI Charles,
I was just re-reading your comment, and I wanted to mention one other thing: It sounds like you’re comparing owning a duplex in a high-cost-of-living area vs. owning a single-family home in a low-cost area. But that’s not an apples-to-apples comparison.
To make a real comparison, find the difference between owning a duplex in a high-cost vs. low-cost area. Or find the difference between owning a single-family home in a high-cost vs. low-cost area. But you can’t compare a duplex to a single-family residence; they’re not in the same ballpark.
That’s like comparing a high-rise condominium to a barn-house. They’re not comparable.
Also, question your assumption that “only in an expensive state” would people pay to rent the bottom floor of a house. There are duplexes in all 50 states. I grew up in Ohio, where the cost of living is very affordable, and there were duplexes, triplexes, quadraplexes and apartment buildings all over the place.
And when you say “high rent,” you can’t just look at the raw number. You need to calculate the number relative to the acquisition cost, using the cap rate formula. This allows you to understand the rent in relation to the price. http://affordanything.com/2012/01/25/income-property/
Thanks!
Great Post! Travel is big for me and my husband, too. We don’t overspend on the small stuff so we can do the big things in life. I used to get my haircut/color every 3 months which costs about $125 plus tip. It adds up pretty fast in a year. Now, I just get a quick trim once or twice every two years. I can easily save $400 per year this way. The upside is I can donate my hair to Locks of Love once it reaches a certain length. Not only am I saving money for my trips, I am making a child happy.
What an interesting experience! I hope you have many more opportunities to get together.
And…agreed! It’s surprising how little you need to live. Not only just live, but live perfectly happily.
The necessary/discretionary divide is essential. I no longer have any real income — it’s all Social Security and investment drawdown, neither of which are enough to regard as anything more than sustenance — but I still split my budget between “discretionary” and “nondiscretionary.” In the summer, when utility bills are through the roof,” the amount dedicated to “nondiscretionary” is pretty high. But making up for it is easy — simply reduce the “discretionary” side. In the winter, when power bills drop to $60 and water isn’t much higher, that’s the time to make the “iWANTit” purchases. And yes: it surely is a matter of consciously choosing.
I have adopted this definition. “Wealth is number of days forward you can sustain your desired lifestyle without having to work” Therefore, If my monthly cost of living is $3k, and my investments net me $3k+ I have attained true wealth and financial freedom.
Im only 8 more rental properties from this goal !
@SPM — Precisely. Wealth is measured in free time, not in raw numbers. I like your definition … and you’ll reach 8 rental properties in no time! It only took me 3 years to get 6 units, and I moved slowly and conservatively, in comparison to a lot of other investors that I know.
Discretionary income= FREEDOM. I like the idea of “Do you own your stuff or does your stuff own you”. And to quote Sheryl Crow. “It’s not having what you want, it’s wanting what you’ve got”…
I love the observation that, “wealth is measured in discretionary income.” So very true. Savvy individuals recognize that the key is to limit expenses and increase income (passive and portfolio preferred). Therefore, wealth is not measured in terms of a specific income or portfolio value, but the individual’s ability to live their desired lifestyle without earned income.
But cats ARE a necessity! And by extension, their food are, too!
Or at least I’d like to think so. Excuse me, I’m having cat withdrawal because I’m leaving my cat with my Mum while I continue living my nomadic life. I’ll get to take care of 3 cats this winter, though, courtesy of my first house-sitting gig.
And cell phone can be totally discretionary. I’ve been exclusively using my Skype and Google Voice number, while my number-less old iPhone gets used only when WiFi is available. But I work from home, so I don’t need it much. My partner, on the other hand, works a normal job and needs that phone for work.
Right on the mark here, Paula! Most people have completely lost sight of the difference between a want and a need. Great post!
Wow, powerful concept here: Your income doesn’t predicate how wealthy you are or going to be, its all in the discretionary fund! This is the concepts of the New rich, you realize that you really don’t need lots of money or a high paying job to be a globe trotter or pursue other passions, you just have to well. think different, shift priorities and focus on what you want to do.
Great post! I just wrote a similar one about my college experience (and two years after) on $7,000/year, plus $3,000 for world travel every summer. I didn’t know the term ‘discretionary income’ but sure have found your ideas to be true… I’ve recently gone back down to my college spending level days, in order to travel for a year.
Will definitely be following your progress!
That’s awesome! Going back to “the college life” is an AWESOME and super-effective way to save money to travel. After all, most college students only spent money on things that were absolutely necessary. If you do that while you’re working full-time, you can really ramp up the savings.
I heard you mention this post on the BiggerPockets podcast. This is a topic that’s so relevant to Americans, I think. Many people don’t realize that most of what they spend money on is keeping up with the Jones’. One of my mentors, Gary, teaches a class called Financial Freedom Principles. He spends time on this subject in his class but you don’t often hear it discussed in this manner. This is what drew me to this post.
Gary says something like, ‘Being broke is a temporary condition. Being poor is a state of mind.’
I had a friend who, shortly after graduating from college, remarked: “Before, we were students. Now we’re just poor.”
I had another friend who would say, “I’m not poor. I’m just momentarily cash-strapped.”
Guess who ended up doing A LOT better in life?