Discreet Earnings vs. Spending Money: Significant Distinctions & Examples Explored
In simple terms, discretionary income is the money left over after paying taxes and essential expenses like food, housing, and clothing. This surplus plays a significant role in our economy, serving as a barometer for consumer spending power during various economic cycles.
During the COVID-19 pandemic in 2020, the U.S. personal savings rate reached unprecedented highs, surpassing 30% due to lockdowns and reduced spending. However, from the end of 2021 into 2022, this rate moderated to around 7%, and has since dropped to 3.4% as of June 2024.
Discretionary income is often used for nonessential spending on vacations, luxury items, and other discretionary goods and services. In a strong economy, people often spend their extra money on these items, boosting various sectors of the economy.
Economists use discretionary income alongside disposable income to calculate important economic indicators like the marginal propensity to consume (MPC). The MPC is a ratio that shows how much of an increase in income is likely to be spent, rather than saved.
The so-called 50-20-30 rule suggests that 50% of net income should go towards living expenses, 20% to savings or investments, and 30% to discretionary spending. This rule is a useful guide for managing personal finances, but the ideal percentage of discretionary income may vary based on individual circumstances.
Experts generally agree that around 10-30% of take-home pay should consist of discretionary income. When income decreases, discretionary income typically diminishes first, impacting spending on nonessential items.
Discretionary income is derived from disposable income, which equals gross income minus taxes. Disposable income is a person's take-home pay, used to meet both essential and nonessential expenses.
It's worth noting that the U.S. government calculates eligibility for federal student loans and student loan repayment plans based on discretionary income. This highlights the importance of discretionary income not only for individual financial management but also for government policies and programmes.
Discretionary spending is an important part of a healthy economy. In a thriving economy, this spending fuels growth in sectors like tourism, luxury goods, and entertainment. However, it's crucial to strike a balance between discretionary spending and savings, as excessive spending can lead to financial instability, as seen in 2005 when the U.S. personal savings rate went negative for four consecutive months.
In conclusion, understanding discretionary income is key to understanding consumer spending patterns and economic health. By managing discretionary income wisely, individuals can secure their financial future, and nations can foster economic growth and stability.
