Loading the player...

What is 'Discretionary Income'

Discretionary income is the amount of an individual's income that is left for spending, investing or saving after paying taxes and paying for personal necessities, such as food, shelter and clothing. Discretionary income includes money spent on luxury items, vacations, and nonessential goods and services. Because discretionary income is the first to shrink amid a job loss or pay reduction, businesses that sell discretionary goods tend to suffer the most during economic downturns and recessions.

BREAKING DOWN 'Discretionary Income'

Discretionary spending is an important part of a healthy economy. People only spend money on things like travel, movies and consumer electronics if they have the funds to do so. Some people use credit cards to purchase discretionary goods, but increasing personal debt is not the same as having discretionary income.

Discretionary Income vs. Disposable Income

Discretionary income and disposable income are terms often used interchangeably, but they refer to different types of income. Discretionary income is derived from disposable income, which equals gross income minus taxes. Disposable income, in other words, is a person's take-home pay used to meet both essential and nonessential expenses.

Discretionary income is what is left over from disposable income after the income-earner pays for rent/mortgage, transportation, food, utilities, insurance and other essential costs. For most consumers, discretionary income gets depleted first when a pay cut happens. For example, if a person makes $4,000 per month after taxes and has $2,000 in essential costs, he has $2,000 in monthly discretionary income. If his paycheck gets cut to $3,000 per month, he can still meet his essential costs but only has $1,000 left over in discretionary income.

Discretionary Income and the Economy

Discretionary income is an important marker of economic health. Economists use it, along with disposable income, to derive other important economic ratios, such as the marginal propensity to consume (MPC), marginal propensity to save (MPS) and consumer leverage ratios.

In 2005, in the midst of a debt-fueled economic bubble, the U.S. personal savings rate went negative for four consecutive months. After paying for necessary expenses out of disposable income, the average consumer spent all his discretionary income and then some, using credit cards and other debt instruments to make additional discretionary purchases beyond what he could afford.

Aggregate discretionary income levels for an economy fluctuate over time, typically in line with business cycle activity. When economic output is strong, as measured by the gross domestic product (GDP) or another gross measure, discretionary income levels tend to be high as well. If inflation occurs in the price of life's necessities, then discretionary income falls, assuming that wages and taxes remain relatively constant.

RELATED TERMS
  1. Discretionary Expense

    A discretionary expense is a cost which is not essential for ...
  2. Income Effect

    In the context of economic theory, the income effect is the change ...
  3. Discretionary Beneficiary

    Discretionary beneficiaries are those named in a trust or similar ...
  4. Active Income

    Income for which services have been performed. This includes ...
  5. Business Income

    Any income that is realized as a result of business activity. ...
  6. After-Tax Income

    The amount of money that an individual or company has left over ...
Related Articles
  1. Insights

    Explaining Consumer Discretionary

    Consumer discretionary is a term from economics that refers to the sector of the economy that produces goods and services that are nonessential.
  2. Insights

    Disposable Income

    Disposable income is the money a person has left over after all taxes have been paid. Other deductions that may affect the amount of disposable income are employment deductions for things like ...
  3. Trading

    Let Consumer Spending Trends Lead You To Big Gains

    Investors is search of ideas should consider Peter Lynch’s advice to invest in what you know. But when is a consumer discretionary ETF the best bet and when should you double down on individual ...
  4. Investing

    3 Dividend-Paying Consumer Discretionary Mutual Funds (VCDAX)

    Discover consumer discretionary mutual funds and learn about three dividend-paying consumer discretionary funds available
  5. Investing

    5 Best Dividend-Paying Consumer Discretionary ETFs (RTH, RCD)

    Discover the five best dividend-paying consumer discretionary ETFs, which is one of the best-performing sectors in the market since 2013.
  6. Investing

    The Time is Right For Discretionary ETFs

    The consumer discretionary sector is still in its seasonally strong period and that could be good for this ETF.
  7. Insights

    Calculating the Consumption Function

    The consumption function shows the level of consumer spending as it relates to disposable income.
  8. Investing

    Profit from Consumer Spending with this ETF (VCR)

    As Americans finish purchasing the last of their holiday gifts, the consumer discretionary sector will continue to be one of the primary beneficiaries.
  9. Personal Finance

    Good News! Americans Are Earning More

    After years in the doldrums, incomes are up – and not just for the 1%. Here's who's benefiting.
  10. Investing

    Comparing Consumer Discretionary Mutual Funds to XLY (VCDAX)

    Discover the top four consumer discretionary funds positioned to rebound on the back of the rise in consumer spending and learn how they could help your portfolio.
RELATED FAQS
  1. How do I know how much of my income should be discretionary?

    Understand the difference between discretionary income and disposable income. Learn how much of a person's income should ... Read Answer >>
  2. Why do economists think it is important to track discretionary income?

    Learn about the importance of discretionary income to economists, particularly for economists who emphasize consumer spending ... Read Answer >>
  3. How does discretionary income relate to autonomous consumption?

    Learn what differentiates discretionary income from autonomous consumption, how the two relate to each other and what place ... Read Answer >>
  4. What is the difference between residual income and savings?

    Discover the differences between various forms of income and their functions, including residual, disposable and discretionary ... Read Answer >>
  5. What are some ways to increase your disposable income?

    Learn what disposable income is and how you can increase your disposable income by working a second job, starting a small ... Read Answer >>
  6. What is the difference between gross income and earned income?

    Being able to distinguish between earned income and gross income is an important tool in preparing for and filing your individual ... Read Answer >>
Trading Center