Understanding Discretionary Expenses

December 27, 2020 · 9 minute read

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Understanding Discretionary Expenses

Want a shiny new pair of shoes? A turmeric oat milk latte? A just-released, flatscreen TV? To go skiing in St. Moritz? Or, to buy the latest tech gadget? Sure, these things could be fun to experience. But, are they truly needed?

When it comes to personal finances, there are essential needs and wants that a person could opt not to spend money on. Put another way, there are discretionary expenses (aka unnecessary) and non-discretionary expenses (aka essential).

What is a discretionary expense? Examples of discretionary expenses are any costs that are not required or driven by individual preferences. They’re optional things that people can choose to spend (or not to spend) money on—such as, paying for a vacation, eating out, or shopping for a game console.

By contrast, essential spending—also called non-discretionary expenses—are needed for day-to-day life. Typically, their cost isn’t affected by an individuals’ in-the-moment choice—such as, the cost of rent, monthly utilities, gas for a car, or paying for transportation to work.

When trying to separate a discretionary expense from a necessary cost, one place to start is with tracking monthly spending. The ability to identify discretionary expenses is crucial to develop healthier spending habits, including budgeting.

Because they’re unnecessary, discretionary expenses are a good place to trim one’s budget or to find funds that might otherwise get saved.

What Are Discretionary Expenses?

So, how can someone identify discretionary expenses? To do so, it can be helpful to take a step back and consider what a necessary expense is.

Needs are more or less mandatory or unavoidable. For example, housing expenses, like mortgage payments or rent, are things a person can’t do without.

Most workers have to pay federal and state taxes on their work income. People with outstanding debt are generally expected to make monthly payments. And, in everyday life, food (aka groceries) and fuel (aka gas or public transit) are typically must-haves.

Some of these necessary expenses will still be variable, changing every month. For example, an electricity bill may go up and down depending on how much time is spent at home and the season of the year.

Recommended: What Is Discretionary Income?

Understanding Needs vs. Wants

Now, any expenses beyond core costs are considered discretionary—it’s a matter of needs vs wants. Typically, discretionary costs reflect wants. They aren’t needed for a person to function in day-to-day life. Rather, they have more to do with lifestyle.

Broadly, discretionary expenses could include vacations, entertainment, luxury items, eating out in restaurants, and electronic gadgets.

Exactly what constitutes a discretionary expense isn’t always cut and dry. As with any personal choice, there’s likely a significant element of subjectivity.

For example, while food is generally thought of as a necessary expense, some types of eating are actually discretionary. Eating at restaurants is avoidable and often more expensive than making food at home. Buying luxury ingredients at the grocery store (ahem, imported cheeses) can be more costly than sticking to pantry staples.

Similarly, clothing, in many instances, is a necessary expense. If a person lives in a cold climate, owning an insulated winter coat is a legitimate need. (Without one, the person could risk their health or well-being).

Still, there’s tons of variation in the price of winter coats. Choosing to buy a utilitarian coat often costs much less than buying a designer jacket .

Even within the categories of essential expenses, individuals can exercise their discretion to save money.

Budgeting for Discretionary Expenses

Tracking discretionary expenses is key in case times get tough or a person wants to tighten up their budget. When planning for future financial goals, like saving up for a mortgage down payment, finding places to pare back can add up.

One of the most important strategies for tracking discretionary spending is creating a household budget. Budgeting may help individuals to ensure there’s enough money to cover necessary expenses and bills. Once those needs are covered, it’s possible then to set the remaining money aside for discretionary spending.

Here are some ways to budget:

Tallying Monthly Income and Earnings

To start building a monthly household budget, tally up total monthly income after taxes. Be sure to include all sources of income, such as salary, any money made from freelance or side gigs, and passive earnings, such as rental property income.

Understanding Regular Expenses

Next, a would-be budgeter might want to write down all necessary expenses—adding up their associated costs. Some regular expenses could vary from month to month. So, it might be helpful to go back and look at costs incurred every month during the last year. This way, it’s easier to average the amounts that get spent on X, Y, and Z essential costs.

Whenever budgeting, it’s important to determine whether incoming money can cover both regular and surprise costs. Ideally, an individual would have enough money saved or in income to pay for all necessary expenses.

Setting Aside Funds for Later

On top of short-term expenses, some budgeters like to allot amounts each month either to savings or to a rainy day fund. With some money management accounts or retirement plans, users can directly deduct funds from a paycheck on payday.

Automating savings might cut the temptation to shop, as these funds are already transferred to another vault or account (and, hence, harder to spend).

If money isn’t being auto-saved, budgets can be updated to include savings under the discretionary fund category. Over time, as savings grow, squirreled away funds could go towards pursuing long-term financial goals—like, a home down payment, starting a kid’s college fund, or investing for retirement.

Tabulating a Discretionary Expense Budget

Once essential expenses have been budgeted for, a list of discretionary spending costs can be drafted—covering broad categories that might include trips, entertainment, savings, or eating out.

When either income drops or the cost of a necessary expense goes up, it can be necessary to update one’s budget accordingly. Making cuts to discretionary expenses may be one place to find more cash.

Budgets could rank, for instance, their discretionary according to what’s least or most important. A food lover, to name one example, might want to allot more to dining out than an avid skier.

With discretionary expenses prioritized and mapped out, it can be easier to tighten a budget—identifying easier-to-cut-back-on items.

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Budgeting Strategies

When it comes to budgeting, there are numerous strategies. And, some are particularly suited to tracking discretionary spending. Here’s a look at common budgeting strategies:

The 50/30/20 Rule

The 50/30/20 rule was popularized by Elizabeth Warren and Amelia Warren Tyagi in their book All Your Worth. The idea behind this strategy is that monthly income is divided proportionally between three categories: 50% goes to essential needs, 30% goes to discretionary spending, and 20% goes to savings.

This strategy prioritizes savings, removing it from the category of discretionary spending and making sure it’s part of every month’s budget. This budgeting strategy takes a broad view and can be good for people who are easily overwhelmed by tracking details.

Line-item Budgeting

For those who love to dive into the nitty-gritty details of spending habits, line-item budgeting might be a better fit. Line-item budgeting can involve breaking out a spreadsheet, examining expenses in fine-toothed detail.

For example, rather than simply having a broad category for all groceries, a line-item budget could break down how much gets spent on buying meat, vegetables, dairy, bread, prepared foods, and coffee. Naturally, the more details that are tracked, the more information a budgeter has on exactly where their money is going.

There may even be pockets of “essential” spending—for instance the types of groceries being bought—that could be pared back. Rather than helping a person to allocate funds, a line-item budget focuses on tracking spending.

It can also help people to compare their spending habits over extended time periods, such as a month or a year.

Making comparisons in this way can help keep spending in line with previous months. Because line-item budgeting is a spending tracking system, it doesn’t necessarily help build toward goals, like savings or retirement. It’s not designed to cut costs.

Envelope Budgeting

Envelope budgeting can be a useful way to track discretionary spending for two reasons: 1) It’s tangible, and 2) it’s strict. When using the envelope method, a person writes down their discretionary spending categories on individual paper envelopes. Next, they decide how much they’re willing to spend in each category.

To limit the urge to spend beyond the budget, only the allotted amount is placed—as cash—in each envelope. Afterwards, just the cash in that envelope is used to make purchases within that category of expenses. The idea is to train oneself to avoid using debt or credit cards, which can encourage quick spending.

And here’s the rub, once the cash within a given envelope has run out, it’s gone. Envelope budgeters strive not to spend beyond the used up funds.

So, if the entertainment fund has run dry, then it’s Netflix at home instead of going out to the movie theater. And, if a person blows through their eating-out budget, it could be fun to do a refrigerator sweep. Often, a tasty meal can be whipped up with groceries that have already been purchased.

Though this budgeting approach may sound harsh, it can provide stricter guardrails that help individuals to spend within their means.

For some, adopting this “tougher” approach to budgeting can help reinforce tighter spending habits.

Zero-Based Budgeting

Zero-based budgeting is another way to track spending. The idea behind this budgeting strategy is that every dollar of income has a designated role and can be assigned as an expense. In this way, one’s income minus expenses equals zero.

Zero-based budgeting can take a little bit of extra work, since individuals would need to sit down at the start of each month to assign exact dollar amounts to necessary expenses, discretionary expenses, savings, and other costs.

Zero-based budgeting aims to stick within the dollar amount assigned to each expense. Budgeters, here, seek to stop spending in each category when the allotted dollar amount gets spent.

Still, it may not always be possible to avoid running over the anticipated budget. In those cases, the amount spent in excess of the budget could be subtracted from discretionary funds in the next month—or, perhaps the budgeter may want to allocate more funds in the future for discretionary categories.

Tracking Spending with a Budget

One part of adopting a budget is finding a tracking system that works for the long haul. So, when figuring how to track spending, it can be helpful to go with the approach that fits individuals’ financial goals and habits.

Online budget tracking tools are one way to help make sense of spending. With SoFi Checking and Savings®, members gain access to spending reports and budgeting tools.

Track spending with SoFi Checking and Savings.

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