Not all spending is equal.
I break spending into two camps: structural spending and discretionary spending.
Structural spending includes basic care and feeding.
- Rent or mortgage
- Utilities (heat, hot water, electricity and gas)
- Medicine for chronic illness
- Education for children
These are essential ingredients to daily life. They are necessary, but not sufficient for a generally happy life. They lay the groundwork for all of the things that make life interesting.
Discretionary spending is where all the rest of your money goes.
In the bad-old days, I would have equated discretionary spending with “fun money”. This is wrong. Discretionary spending includes money set aside for short and long-term savings, debt repayment, money set aside for known future expenses, and fun money.
As Side Note About Debt
Did it surprise you that I categorized debt repayment as discretionary spending? If you answered yes, that’s a major red flag.
In many, if not most cases, debt is a choice. At first, debt is something you’re willing to live with. But over time it becomes something that you can’t escape without help.
At that point debt seems like a structural expense. But it’s not, if you’re doing it right. You’re going to need food for the rest of your life. You’re going to need a warm place to live for the rest of your life. Are you planning to live with debts for the rest of your life?
I don’t want to get sidetracked too much onto debt, so just know that in my opinion, debt is a discretionary expense.
The Big Picture
To put structural and discretionary spending into the big picture, we start with our income.
Just imagine your income as a circle. We’re going to cut that circle into two pieces. One piece is structural spending, the other piece is discretionary spending.
Here is what it would look like if we split our total income into half discretionary and half structural spending.
The whole pie represents our income. We’ve allocated our income evenly to structural and discretionary expenses. What would this actually mean in terms of lifestyle?
Could you get by if you allocated your income this way?
Some personal finance gurus recommend this sort of breakdown with the 50/30/20 budget. The 50/30/20 model allocates 50 percent of income toward living expenses, which includes basically everything that I’ve classified as structural expenses. The 20 percent goes to savings. And the 30% goes to all of your “wants”.
Keep in mind that all of these numbers are after taxes.
The thing to understand is that the circle stays the same size. No matter how much you earn or how much you spend, the size of the circle always stays the same.
The tension between structural and discretionary spending is what determines how we are able to live. If we choose to live in a more expensive house, then the blue side grows, leaving a smaller red side. If we have lots of debt, then the red side grows, leaving a smaller blue side. The quality of our retirement depends on the size of the red side, because the red side is where our long term savings goes.
Now, I want you to take some time to think about all of your expenses, including debt repayment, including contributions to short and long term savings as well as donations to charity. Think about how much you spend on fuel for your car, eating out, vacations, preschool tuition, everything.
Write it down.
After you’ve got all your expenses on paper, sort all your expenses into either structural or discretionary categories to answer two questions:
What percentage of your expenses are structural?
What percentage of your expenses are discretionary?
I’m going to follow up with another post on what money management means in the context of this simple model of expense categorization that I’ve shared with you here. In that post I’ll share more insights and strategies for managing money more effectively to give you enough for everything you want to do.
In the meantime
I would love to hear about what it’s like for you to think about your spending as structural or discretionary. How does it change your perspective on your own money management strategy?