I recently read an article from a financial planner stating that net worth is your most important financial number. As a reminder, your net worth is what’s left over after you subtract your total liabilities (loans, debts, etc.) from your total assets (home, car, investments, etc.).
In fact, if you’re curious how your personal net worth stacks up against others in your age group, here’s a January, 2015, article from the Motley Fool that you may find interesting.
And while I think net worth is indeed an important number, I disagree that it’s your most important financial planning number.
I believe the most important personal finance number is your “MDI.”
MDI is your “monthly discretionary income.”
For example, if your monthly after-tax take-home pay is $5,000, and your non-discretionary monthly expenses are $4,000, then your MDI is $1,000.
Now let me explain a couple of things.
I’m not too concerned about your gross, pre-tax income because you can’t actually spend this amount of money. If you receive a paycheck, it’s almost always after taxes have been deducted. So in this example as well as in the financial planning I do for my clients, I’m really interested in after-tax money that you can spend.
As far as non-discretionary expenses go, it could be argued that every expense is discretionary. But when I’m talking about calculating your MDI, non-discretionary expenses include things that you’ve made a previous agreement to pay in the future. This could include rent, a mortgage, car payments, credit card payments, utilities and more. Think of these as expenses for which you receive a monthly bill.
But there are other non-discretionary expenses. Things like property taxes or ad valorem taxes that you must pay, even though they’re only paid once a year instead of monthly.
Finally, there are non-discretionary expenses like groceries, fuel for your car, and things that while technically discretionary – and often variable from month to month – it would be difficult to forgo these things completely.
Rather than getting buried in discretionary versus non-discretionary expenses, the important idea here is what, if anything, you have left over at the end of every month once expenses have been paid.
The reasons I believe MDI is your most important financial number is because if you don’t have a positive MDI, you’ll wind up with “not worth” instead of net worth.
But achieving a positive MDI is only the first step.
What you do with your MDI is even more important.
Let’s stick with the example introduced above and assume you have $1,000 of MDI. What do you do next?
Well, some people not only spend all their MDI, they spend more than they earn and their total expenses are greater than their after-tax income. But this doesn’t mean they have negative MDI. They actually have monthly discretionary income, but it all gets spent and then some.
The other extreme is some people with $1,000 MDI save every penny of it. While extreme, I think we can agree that this is a better approach than spending it all. However, this is problematic as well.
Even though your savings (and your net worth) are growing with this approach, what are you giving up or missing out on as a result? What is your opportunity cost for this strategy?
Clearly saving something is better than the alternative, but I believe you can unwittingly make sacrificial life choices and decisions by over-saving. This same risk is also achieved by under-spending.
Yes, I’m a financial planner who is telling you that you really can save too much. Or you might even need to consider spending more.
And this idea of MDI and achieving balance in your current cash flow and lifetime financial plan works whether you’re 45 and in the prime of your career or 75 and fifteen years into retirement.
So here’s the million dollar question(s)?
How do you determine how much savings is enough? And how much is too much?
How do you determine how much you can afford to spend without jeopardizing your comfort and confidence in the future? How can you spend purposefully instead of making spending decisions from a fear-based mentality?
Well, coming from me, the answer probably won’t surprise you . . . you need to figure out where you are today, where you want to go, and how you’re going to get there. Safely and on time. Financially speaking, of course.
This is what financial planning is.
But you don’t necessarily need to hire me or another financial planner to help you figure this out.
You’re smart. You can do this.
Maybe start with a tool like Mint. It’s free. It’s secure. And it’s a great place to start to get a handle on where you are now with regard to your income and your spending.
Then, you can turn to some calculators like those at DinkyTown to figure out how much money you’ll need based on when you want to retire, how much you want to spend in retirement and what you’re willing to save between now and then.
This is a simple approach – perhaps too simple – but I’m a big fan of simple, and it’s better to start somewhere than to not start at all.
So that’s why I think your monthly discretionary income (MDI) is the key to your financial planning and something you should pay attention to.
The key word here is “discretion” and your capability to exercise it prudently.
Updated March 17, 2020
I recently revisited this topic in episode 6 of the Women’s Retirement Radio podcast:
Click the play button below to listen:
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Episode 6 Show Notes:
Among all the financial data and information that is necessary to build and maintain your financial and retirement planning, there’s one number that, in my opinion, is important above all others.
It’s your “MDI” or monthly discretionary income.
This is the average number of dollars you have each month after you’ve paid all your normal bills and supported your lifestyle. This number can be positive (surplus) or negative (deficit).
Having a surplus MDI each month affords you additional financial flexibility and choice which, in my experience, is something most people seem to appreciate.
Figuring out your personal MDI is pretty simple and straightforward.
Get your last 3 months statements from all your spending accounts (checking, credit cards, etc.) or login online and access this same information. Add up your total spending for the last 90 days and divide by 3 and this will give you your average monthly spending.
However be sure not to double-count your credit card transactions if you’re paying off your credit card bill every month from another spending account.
Once you have your average monthly spending, simply deduct this number from your monthly take-home pay. This will give you your MDI.
Here are a couple of software tools & apps to help you with this process:
There are countless benefits to calculating your personal MDI and reconfirming it every year or so. We cover many of these in this episode.
If you have any questions about your MDI or anything else covered in this episode, please get in touch and let me know.
Thanks for listening.
Episode 6 Transcript:
Hello there and welcome to another episode of Women’s Retirement Radio. Today I want to talk a little bit about your most important financial number. I wrote a blog post about this a just a few years ago in which I referred to your most important financial number. And I went on to label it what I call to, what I refer to as MDI which stands for Monthly Discretionary Income. But let me take a step back and explain a little bit about what I’m talking about here.
I regularly encounter people that are interested in talking about financial planning and talking about retirement and thinking about what life’s going to look like in retirement. And one of the questions that ultimately that I ask everyone, it’s not one of the first questions but ultimately a question that I ask everyone is how much does your lifestyle cost you? What does it cost for you to live in an average month? And that should be all inclusive, that should be the cost of insurance and health care, and putting gas in the car and food on the table, and paying for housing and utilities and clothes, travel, doing things for yourself, your family, your children, whatever is relevant to your situation. It’s important to have a handle on what your lifestyle costs. And that’s why I often refer to what I do as lifestyle financial planning because ultimately we need to be able to figure out a way to support or continue to support your lifestyle.
And when I ask people that question I often get an answer where people tend to talk in generalities, “I spend about $6,000 a month,” or, “I think it’s about $8,000 a month,” or, “I’m pretty sure it’s $15,000 a month.” The amount here is not important it’s the element of how vague people seem to be around this number. And it’s an important number and I’m going to talk a little bit more here in a moment about why that is. But first let me be clear I’m not suggesting that you need to budget and become a slave to your budget, that you need to plan and account for where every single penny, nickel and dime comes from and goes in your spending each day. I’ve can’t think of anyone I’ve ever met that relishes the idea of budgeting. And so, I’m not suggesting here that a super detailed hardcore disciplined budget is the answer but I do think that it warrants a little bit of time and attention to figure out exactly what your lifestyle costs.
And I could give multiple examples of when I’ve challenged clients on this that have told me one number and I’ve said, “Okay, well I want to, for whatever reason I’m not sure that how accurate the number that you’ve given me is so I want you to spend some time and figure out exactly what you’re spending.” And they often come back to me surprised because they may find that they were spending 20, 30 40% more per month than they thought they were. And I probably don’t have to tell you how important it is to figure this out and come to this realization sooner than later because it’s going to have a big impact on your future of financial planning and your retirement lifestyle and your retirement planning.
So let’s say you’re with me so far and you agree that yeah maybe it does make sense to figure out exactly what I am spending. I think this part paralyzes a lot of people. I think they think about well, “Where do I start?” Or, “How do I get my arms around this?” Or, “Is this going to take me hours or even days to decipher and get down to what I’m actually spending?” And frankly no I don’t think it has to I think it’s actually pretty simple and straight forward.
The best thing to do is to first of all identify all of your spending accounts and so these are typically checking accounts where you’re writing checks or paying bills, either writing physical checks or using online bill pay or something like that. So if you have a checking account or multiple checking accounts for you or your family those are spending accounts, others are credit card accounts. So if you’re doing spending on a credit card those count as well. If you have a debit card typically those are going to be tied to your checking account. If you’re making ATM withdrawals typically those are going to be tied to your checking account. So, and frankly if you’re paying off your credit card every month like you should be or I would encourage you to you’re probably paying that off out of your checking account as well.
So you may be able to just focus on your checking account. And what I would encourage you to do is go online to your bank and download the last 90 days of transactions. And so basically you want to go to the account activity and you can typically download this as a PDF or into an Excel spreadsheet. But you want to get the last 90 days of transactions out of any of your spending accounts. So if it’s just your checking account that’s fine, if you have additional accounts whether those are checking your credit cards those are fine as well. But for each of those accounts I want you to download the last 90 days of transactions and then if you can download those transactions, transaction data into an Excel spreadsheet this actually becomes pretty quick and easy because you can use some of the Excel functions to basically add up all the transactions and figure out how much you’re spending.
But whether you’re using an Excel spreadsheet or not that’s really the extent of this exercise is if over the last 90 days you’ve spent let’s say $27,000 total that’s 90 days is three months, if you spent $27,000 that’s an average of $9,000 a month. Now be sure that you’re not double counting because if you’re making a credit card payment each month out of your checking account but then you’re also counting the actual credit card transactions you could be double counting so be careful of that. But literally you could do this in 15 or 20 minutes, log onto your bank account or accounts, download the information, add up your transactions. If you do over 90 days divid by three that’ll give you your average monthly, if you do over six months divided by six. But I would suggest at least getting 90 days worth because any single month can be a bit of an aberration or it might be a bit of a one off where you have some additional irregular spending or something that’s impacting a particular month. So once you have that information though that’s really the number we’re talking about here.
And then to keep numbers simple let’s say you’re spending $5,000 a month on average. The next question is or the next number we need to identify is how much is your monthly take home pay. So this is not your salary pretax this is after you’ve had taxes deducted, after you’ve made 401k or other employer savings plan contributions, what is your take home pay? And let’s say it’s $6,500 a month after tax so that’s the actual paycheck that you get deposited into your checking account or that you receive over the course of a month. So we’ve gone through the exercise of looking at our 90 day spending, we’re averaging spending $5,000 a month. We have after tax income of $6,500 a month, that means we have monthly discretionary income of $1,500. That’s just the difference between the $5,000 that we’re spending and the $6,500 that we’re getting or earning after tax and after savings each month.
What does that number tell you? Well, first of all it tells you that you’re spending less than you’re earning and that’s important for a number of reasons not the least of which is the flexibility and the additional choices that it affords you. Beyond the obvious that you’re spending less than you’re earning it also means that if you have credit card debt, or a car loan, or student debt, or a mortgage or all the above you’ve got some extra income that you can use to maybe start paying off some of those loans quicker than you would otherwise.
It also means you have additional funds that you can use to save for a child’s wedding, a vacation, saving up for a new automobile so you don’t have to take on another car loan. It just gives you more flexibility and choice. And in the event something happens and you get laid off or are disabled for a period of time and you have to cut back well you’ve already become accustomed to living on less than you’ve been earning. So I’m not saying that a period where your income goes away completely is going to be easier but or easy but it will certainly be easier if you’ve become accustomed to getting by on a little less than you had been earning previously. That also means that any disability insurance that you may have is probably going to go further and will be less impactful to your lifestyle on an ongoing basis for the period that maybe you’re not earning the same amount of money.
So I think this number is incredibly important first of all because it tells you where you are. It amazes me that so many people are introduced to me and say, “Yes Russ, I am ready to sit down and tackle my retirement planning or my financial planning.” And we ultimately get to the question of, “Well, how much are you spending now?” And I can just tell by the look on their face that they really don’t know and that’s fine. I don’t expect everyone to know this but I would encourage everyone that’s listening to figure this out sooner than later.
And even if you and I never talk, even if you never hire a financial advisor or a financial planner I still think this is important information for you to know and I would encourage you to make it a priority to get this figured out ASAP. Even if you think you know what you have been spending or what you plan to spend going forward I think that every so often, maybe every couple of years or so, go through this exercise and just check your math, make sure that you’re expectations are in line with reality and make sure that you’re actually spending what you think you’re spending. And chances are you will be but it’s certainly worth checking that every once in a while because there’s something called lifestyle creep and as your income maybe goes up over time it’s very easy to find your spending creeping up over time as well so it’s something to be aware of.
Also once you know your monthly discretionary income or what I think of as one of your most important financial numbers you can use it as a progress bar, as a tool to figure out are you making progress or not. You can use your discretionary income on a monthly basis to build up a healthy cash reserve. You can use it as I mentioned earlier to pay down debt or to save for a future goal or something that’s important to you. You can use it to help cover gifts at Christmas as opposed to having to go in debt like you’ve maybe done it in the past.
So it allows you frankly to plan ahead and to think ahead and not be in a situation where you have to operate on a reactionary basis with your money. Because that is unfortunately an environment that leads to rash decisions and sometimes poor choices. And frankly just in simple terms it’s really difficult to plan ahead if you don’t know where you are today. It’s important to know where you’re starting from and to take inventory of your current situation before you can make substantial progress and plan ahead and start building the life that you want for yourself and for those that you care about.
Living below your means also has some additional benefits. For example, if you’re spending less than you’re earning and you’ve been able to build up a little bit of a cash reserve that likely means that you can also do some other things to introduce some additional flexibility and choice in your life. For example, if you’ve got a little bit more cash on hand through setting aside a cash reserve and you’re living below your means perhaps that would give you the opportunity to increase your deductibles on your auto or your homeowners insurance. And if you increase your deductibles that allows you to pay a lower ongoing premium. So that might allow you to actually save money today. You might have a higher deductible in the event that you have an insurance claim in the future but hopefully there’s low odds of you having an insurance claim. And so, maybe you’re able to further build some flexibility and some cushion into your monthly cash flow and savings by lowering your insurance premiums by raising your deductibles.
Further, rather than going into debt, credit card debt or financing a car purchase or whatever the case may be you now have more cash on hand where you can either make a larger down payment on an automobile or even a home but that also allows you to be a little bit more strategic about your financial decisions. And frankly if you have more cash on hand and you’re living within your means that’s typically going to be indicative of the fact that you’re going to be less reliant on credit and loans and debt which is likely going to give you an opportunity to improve your credit score. So in the event that you do need to in the future go out and get a mortgage or some kind of debt it’s likely you’re going to be in a better position to get more favorable terms on the basis of having a higher credit score.
So, there’s a lot of ancillary benefits that come into play here but frankly in my mind it just makes life a little easier and it gives you more choice. And ultimately I find that the people that I work with having more choice and more flexibility is important to them. They don’t want to, you don’t want to feel like you’re ever painted into a corner that you have, that your back’s against the wall and you have a limited set of options or choices. More choice in my experience usually means more freedom, more independence, less reliance on others. And it can even mean that people are less reliant on you and that can be good for all involved.
So remember it’s as simple as just downloading or accessing your last 90 days of spending transactions across all of your spending accounts. Again, make sure not to double count. If you’re paying your credit card bill out of your checking account you don’t necessarily want to also check each and every one of your credit card transactions because you could be double counting. If you have questions on that reach out to me and let me know I’m happy to explain further. But it’s really as simple as downloading your expenses for 90 days, dividing by three and that’s going to give you your average monthly spending.
And then you can look at that compared to your after tax take home pay to figure out are you operating in a surplus or a deficit. If you’re in a deficit I would encourage you to do one of two things. See where you can start reducing expenses but also simultaneously see what you can do to increase your income. This is not a mutually exclusive, it’s not either or. While many people in the financial advice and financial services industry focus just on cutting costs and savings, savings, savings, I think that the opportunity to earn more, to get a raise or a promotion or maybe a new job that pays more does not get enough attention or the attention that it should. So think outside the box and don’t just focus on cutting expenses although that might be a worthwhile exercise as well but also consider what can you do to earn more money. Because you can actually go with this from both ends, you can simultaneously cut costs and earn more money and that’s just going to accelerate your opportunity to get into a surplus situation where you have discretionary cash each and every month.
If you do have discretionary cash currently make sure you build up a cash reserve, I would recommend at a minimum three months of expenses. So if you’re spending $5,000 a month in average expenses I would do everything you could to build up $15,000 so three months worth of expenses and put it in a safe liquid interest bearing account.
There are several like online I’ve recommended to my clients like Marcus, American Express personal savings, there’s several out there that are going to pay several multiples of the interest that you would get if you just put that into a traditional bank and the money’s liquid and you can get to it at any time. And that money’s there for those situations when you need it but you want to try to leave that money alone. And I would say three months at a minimum, six months is a better target. And if you’re in a job or career where you have irregular income, so maybe you are in sales and you have a commission job and you don’t necessarily earn the same amount of income each and every month you might even consider carrying more in a cash reserve like nine or 12 months just to give you a little bit more of a cushion in the event that maybe there’s a dry spell between commission checks or something like that.
The final thing I’ll mention is tools so while I think the simple straightforward approach is usually best there are some great tools out there that can help you not only figure out what you’re spending on an average month but they can also help you track your spending relative to your income. They can actually calculate your monthly discretionary income for you and it can actually help you manage and monitor this whole focusing on this important number, making that a little bit easier.
And so whether you access them on your smartphone or on the computer some tools you might want to consider are mint.com M-I-N-T .com. This is a tool that I’ve used for many years, I’ve recommended to many folks, it’s free. They make their money by basically putting ads in front of you in the software. It’s owned by a company called Intuit who is also the makers of TurboTax. They’re a large well funded company. And so Mint is a great option, it’s free and you can basically connect all of your accounts spending and otherwise and it will basically help you organize and track what money’s coming in and what money’s going out.
Another great tool especially if you like spreadsheets is called Tiller, T-I-L-L-E-R. The website is tillerhq.com. And they will allow you to also connect your accounts but they will pull your transaction data into a Google spreadsheet where you can do a lot to customize how you analyze and look at the numbers. But at the end of the day they’re largely doing the same thing, they’re just helping to automate the collection and organization of your income and spending transactions.
And a third one I’ll mention which I’ve started using personally in the last several months I really like it a lot it’s called You Need A Budget or a why YNAB for short, so youneedabudget.com. It’s an online tool, they also have a smart phone app and it helps you to budget. I shouldn’t say budget, it helps you organize and analyze your spending accounts. So it’s really based on helping you simplify the process of gathering, organizing, categorizing and seeing where your money’s coming from, where it’s going. It does a nice job of giving you a report where you can quickly and easily see what is your monthly discretionary income. It also has some other nice charts and features. And they’ve got a unique philosophy around money and budgeting and how you handle expenses. Whether you subscribe to that philosophy or not I still think You Need A Budget is a great tool along with Tiller and Mint.
So the bottom line is I think that among all of the numbers and data that are relevant to your financial planning, your retirement planning, I think one of the most important if not the most important is what I’m calling your Monthly Discretionary Income, your MDI. And in plain English it’s just how much money do you have leftover at the end of each month after you paid all the bills or do you have money left over at the end of the month after you paid all the bills. And I recognize some of you listening to this won’t but there’s an opportunity there to look at these numbers, be more cognizant of it to be strategic and to plan. Come up with a plan of action to figure out how you can get from a deficit to a surplus or how you can be more thoughtful and strategic with your surplus dollars to help build the life and the financial plan that’s important to you and allows you to do the things that you most want to do.
So I hope this has been helpful. If you have questions about any of this certainly reach out and let me know. One other thing I’ll mention is if you go to my website wealthcareforwomen.com on the right edge of the screen is a button, it’s green and it says ask a question. You’re welcome to click that. You can leave actually a voice message for me. I would be happy to answer your questions in future episodes and maybe I’ll even feature one of your questions on a future episode as well. So if you have questions about anything I’ve touched on in this or past episodes or if you have a question that you’d like for me to address in a future episode of Women’s Retirement Radio click that button and leave a voice message and I would be happy to do that. You can also reach out to me via my contact page or via email or whatever’s best for you. So that’s it for today. Thanks for joining me and I look forward to joining you on the next issue or episode I should say of Women’s Retirement Radio. Thanks.
Hey, it’s Russ and real quick just have some disclosure language to share with you. You should consult a financial advisor familiar with the specific circumstances of your unique financial situation before making any financial decisions. Nothing in this broadcast constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. I’m a financial advisor, a certified divorce financial analyst, and an investment advisor representative of Wealthcare Capital Management LLC, an SEC registered investment advisor based in Richmond, Virginia. The views discussed in this podcast are my own and may not be consistent with or represent those of Wealthcare Capital Management.
If you have questions about this or would like to discuss anything else, get in touch and let me know.