How a Discretionary Fund Beats a Discretionary Budget

my discretionary fund is like a magic pot of money

I separate my retirement spending, practically — and even more importantly psychologically — into a baseline budget for basic living expenses and a discretionary fund for optional disbursements. My baseline budget covers what I have decided is the minimum lifestyle acceptable to me. The Discretionary Fund functions as a super flexible pot of money — distinct from my emergency baseline reserve — from which I can pay for goodies, fun, extras, whatever without having to worry about what that spending will do to my budget. Here is how that actually works.

The Baseline Budget

My baseline budget defines my baseline lifestyle. I have chosen to include in that baseline budget living in and up-keeping a country house (instead of a cheaper apartment), having internet access and basic drive-around gas money, eating a meat-and-vegetables diet (instead of a rice and pasta diet), drinking Chivas Regal instead of a cheaper brand, as well as a few other items that distinguish my baseline budget from the minimum budget I could probably survive on. My baseline budget raises my retirement lifestyle from minimal survival to my own personal level of baseline living comfort.

My annual baseline budget ($15,000) is what I had to have as passive income before I could stop working and retire. I had to keep working until I had crossed that passive income threshold. This is an important point, given that my key financial objective has been to retire as soon as possible in order to free up as much of my remaining life as possible. Life is a zero-sum game, after all. I — like you and everyone else — have a set and finite number of days to live. One more day working is inevitably one less day free.

I have taken one more step before turning loose my discretionary spending. Even though my entire baseline budget is covered by my Social Security “annuity” payments, I sleep better knowing that I have an emergency baseline budget reserve “just in case.” So I have one year’s baseline expenses set aside in a savings account. With that in place, I have become very comfortable with my Discretionary Fund spending.

And here is how a Discretionary Fund works for me.

My Discretionary Fund

My passive income surplus over and above that $15,000 annual (or $1250 a month) baseline budget gets moved over once a month into a separate Discretionary Fund bank account. Those discretionary monies accrue there. Whenever I want to do something optional — book a trip, buy a gadget, hire out something I could otherwise do myself — I check my Discretionary Fund balance. If I am comfortable withdrawing from that balance the cost of whatever it is I am considering doing or buying, I go ahead. And I never have to question whether “my budget” can afford the extra cost. Because that is all off budget.

And what if an unexpected unavoidable expense comes up? What if my truck dies… or the well pump goes bad… or I have to travel to see ailing family? Well, my uncommitted Discretionary Fund stands there ready to bail me out.

This way of handling my finances has had a lot of benefits for me.

Benefits of a Fund Approach To My Discretionary Spending

First and foremost, separating my wants from my baseline needs made it clear to me that I could stop working much sooner than I had thought. So this budgetary approach allowed me to retire years earlier to what I knew I would consider a comfortable baseline lifestyle (for me).

Second, keeping a Discretionary Fund — essentially an uncommitted pot of money — has given me maximum flexibility as to what I can do with that money. If, instead, I had developed a discretionary budget – with so much allotted to travel, and so much to entertainment, and so much to gifts, and so on — the result could have been becoming committed to recurring expenses just because I could afford them. Expenses such as car payments, time-share payments, club memberships, obligatory annual trips to destination X, and so on. And an expense that one becomes committed to can no longer be considered discretionary.

The flip side of this is that keeping my discretionary funds uncommitted allows me to pounce on and take advantage of unexpected opportunities for fun when they present themselves (like grabbing a super bargain of a boat on Craig’s List or taking off on a spur-of-the-moment camping trip.)

Thirdly, this financial planning method gives me a very solid psychological safety net regarding my financial future. It is a lot less worrisome to think about — and plan for — an unexpected drop in passive income when I only have to consider how to continue to cover my baseline budget. On that basis, it would be extremely unlikely that I would have to make any adjustments at all to that budget. Anything else would be, after all, just discretionary.

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image courtesy of Stuart Miles at FreeDigitalPhotos.net