“If you have to ask, you can’t afford it.” ~ J.P. Morgan
Many times people, even those who earn high incomes, find that they don’t have as much money to spend as they thought. Trying to purchase items you want without knowing what you can afford could cause you to overspend and fall into debt.
Fortunately, there is a simple method for anyone to identify how much money they can spend on things they want – their “Discretionary Income.” But, how do I identify my discretionary income? The answer is simple – create a budget. In a future post I will outline simple steps for how to budget and establish healthy financial habits. For now, follow these steps:
Step 1: Identify your necessary expenses
You should focus first on how much you spend on necessities each month. Necessities are things that you truly cannot live without (no, Netflix does not qualify). Look for your grocery bills, housing costs (rent/mortgage), utility bills, phone bills, car payment, fuel, and internet bills. The important thing here is that without these you would not be able to live.
Step 2: Identify your “must have” expenses
Here, figure out how much you spend on things that you technically could live without, but you really don’t want to. Look for Netflix and other streaming services, gym memberships, newspaper/magazine subscriptions, cable bills, and hair cuts.
Step 3: How money do you bring home
This step is the simplest of all. Look at your paychecks for the last month. This is your monthly income after taxes – your “Take Home Pay.” This Take Home Pay is what you have availabke each month to spend.
Step 4: Can I afford it?
Now, to determine if you “can afford it,” start with your Take Home Pay and subtract out your necessary expenses. Then, from the remaining balance of your Take Home Pay, subtract out your “must have” expenses.
The amount you have left over is money you are free to do with as you please. Do NOT spend more than you have left over. It is not worth falling into debt if you can avoid it.
If you need additional money, look through your “must have” expenses and see if you can cut out a gym membership that you keep saying you will use one day (but we both know that you never will) or that magazine subscription that just gets added to the “I’ll read that later” pile that keeps growing. This frees up more money every month to spend or save towards a big purchase. Further, if you can delay a purchase, delay it until a deal arrives or you save up enough cash to buy it without borrowing.
I would recommend you save or invest your extra money when you can afford to; however, after saving some for a rainy day and retirement, enjoy your money because you’ve earned it!
Let me know in the comments what “it” was and if you could “afford it.”