Last week, we talked about understanding your net worth. Simply stated, your net worth is the value of your assets (things of value) minus your debt. This is essentially a measure of your wealth and acts as a barometer of your financial health.

Today, we’ll take a look at another important number which will help you remain financially healthy. Many of us look to our salary as a measure of financial success. And, as a result, we often base our spending on how much we make.

If we bring in $60,000, we often spend like we’re making $60,000 a year. The problem is that, although we may bring in $60,000, we really only have a fraction of that to spend on the things we truly want.

This is why it’s important to know your salary AND your discretionary income.

What is discretionary income? It is the amount of money you have left over from your salary after all of your basic essentials have been taken care of.

First and foremost, taxes consume a large chunk of your salary. Between federal, state, and local taxes you could lose up to 35% of your income.

Next, you must pay for all the essentials you need just to live. This includes your mortgage/rent, grocery, transportation costs, basic clothing, and health insurance costs.

Once you’ve paid all of your taxes and your basic living expenses, what’s left over is your discretionary income.

Remember, discretionary income is the money you can use to pay off debt, save, or spend on non-essential items. Most importantly, you pay for your “wants” out of your discretionary income.

This is where many people get into trouble because their discretionary income is often far less than their salary. As a result, they spend money on their “wants” based on their salary, rather than based on their discretionary income.

To determine your discretionary income, start by locating one of your pay stubs. Use it to determine your after tax monthly income.

Now make a list and tally up the amount of money you spend on all of the following each month:

Rent/Mortgage
Heat and other utilities
Phone, cable, and internet
Car payment, insurance, gas, maintenance
Child care
Basic clothing

Subtract this total from your after tax monthly income and you now have your discretionary income, – the amount of money you have left over to save, pay on debt, or use to pay for your “wants.”

This can be a very sobering, but necessary, exercise. While a person could bring home $5,000 a month, after taxes and necessary living expenses, they could easily have only a fraction of that left over as discretionary income to spend on the things they want like eating out, going to the movies, or shopping.

BMWK: What’s your monthly discretionary income?