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Financial Literacy

How to Calculate Disposable Income?

September 21, 2023Back to Learning Centre
Barry Choi
Barry Choi

The term “disposable income” typically refers to any amount of money you don’t really need that can be spent on anything you want. While this concept is great, as it gives you some funds to play with, spending money on random things may not be the best strategy.

Instead of treating all funds you have left over as disposable income, you may want to set a limit so you can spend guilt-free. The struggle that most people face is deciding how much disposable income they should allocate to themselves.

What is disposable income?

Before getting into the details of how much disposable income you should set aside for yourself, you need to determine what disposable income is first.

Generally speaking, disposable income refers to any funds that you have after you’ve paid your essential bills. These bills would include your rent/mortgage, debt, car payments and electricity bills.

Technically speaking, anything else you spend money on would be considered disposable income. However, there are other essentials you need to consider, such as groceries and your internet bill. In addition, you need to factor in any savings.

How to quickly calculate a good disposable income

To help you determine how much disposable income you have; you’ll want to start by creating a budget. Start by tracking all your expenses for a month or two. Log everything from eating out to any debt repayment. Once you know where all your money is going, you can create an accurate budget.

With your budget, list out everything you’re spending money on by category. That could include variable spending on things such as entertainment, presents, and eating out, to planned spending such as savings. Any funds that aren’t accounted for within your budget could be considered your disposable income.

Your budget may have already factored in what you want to do with your disposable income. For example, hobbies, vacations, and entertainment are all technically things you’re spending your disposable income on. The trick here is to think about your money and how it can work for you. Do you want to spend your money on disposable items, or would it be better to save more to help you reach longer term goals, such as buying a home?

Try the 50/30/20 budget

The 50/30/20 budget has become increasingly popular because it’s a practical way to figure out how you should allocate your money. With this budget, you’d set aside 50% of your net income for needs, 30% for wants and 20% for savings and debt repayment. In this case, the 30% for wants is your disposable income.

While this budget is remarkably simple to follow, it’s worth noting that you may need to adjust your numbers depending on your situation. For example, with the cost of housing in parts of the country, it wouldn’t be a surprise if your needs went above the 50% rule. The same things would apply to anyone who’s just started their career. When your income is lower, you’ll have limited funds left over for wants and savings.

Things will change

Many people love the 50/30/20 budget since it’s so easy to understand, but it’s not always perfect. For example, the budget suggests you put aside just 20% of your after-tax income towards savings and debt repayment. Well, if your monthly debt payments exceed 20% of your after-tax dollars, you don’t want to just cut things off. Instead, you should be putting any extra funds you have toward debt repayment. This would apply if you had high-interest debt such as credit card debt.

Another thing to consider is your salary. With the 50/30/20 budget, you’re spending on wants would increase as your income does. That means you’ll be spending more when you earn more. This is known as lifestyle creep. Instead of increasing your spending on wants, why not increase your savings instead? In theory, you could stick to the 50/30/20 budget, but you could decide to make the 30% apply to your savings instead of wants.

For many people, their monthly income will remain fairly consistent, but unexpected expenses will come up that throw you off course. If you’re able to make adjustments to continue saving, you’ll be able to reach your goals quicker.

The bottom line

It’s easy to come up with a number or percentage of your income to dedicate as disposable income, but that doesn’t always tell you the whole story.

What you want to do is decide on a number that makes sense for you. Just because your budget says you have $1,000 in disposable income each month, that doesn’t mean you should start spending it all on random things. Instead, you should think long-term about what you want to do with that money. We’re not saying you shouldn’t spend your money on fun things. You just need to think about your priorities.

Barry Choi
Written by Barry Choi

Barry Choi is an award-winning personal finance and travel expert. He regularly appears on various shows in Canada and the U.S., where he talks about all things money and travel. His website - Money We Have - attracts thousands of visitors daily, looking for the latest stories on travel and money.