What to Do With Disposable Income

Once you’ve written down your budget (monthly take-home pay minus monthly bills/living expenses (cash)/non-monthly expenses/minimum debt payments), what do you do with the disposable income that is leftover?

Commonly I refer to disposable income as “EXTRA” money because that’s the way most Americans view it: you’ve gotten through the month and now you have a couple hundred dollars left that have to be spent!

Woohoo! Party time.

Unfortunately, if you want to succeed financially and take tangible steps toward financial peace every month, then this “extra” money isn’t to be spent on miscellaneous nonsense.

Ideally, your monthly disposable income should go towards savings, retirement funding, and personal goals.

7 Steps to Financial Peace

If you follow Dave Ramsey or have gone through his Financial Peace University class, you’ll certainly know what I’m talking about when I mention ‘the Baby Steps.’

For those of you non-Dave Ramsey fans, the Baby Steps are simply a guide for what you’re supposed to do with your monthly disposable income. What I’ve seen through coaching and personal experience, is that it is difficult to figure out where your disposable income is supposed to go.


There are so many things we’re supposed to be doing and so many goals that we’re trying to work towards. Should you be paying off debt or investing for retirement? Should you be building an emergency fund or saving for your children’s college?

Or how about on a smaller level…should you save to go on a vacation or should you wait until you’re out of debt?

Should you do a little of each and make marginal progress in every area, or should you focus on one at a time and make significant progress?

One of the most important budgeting principles that I teach is that EVERY DOLLAR MUST HAVE A NAME. Another important principle is learning to focus on one thing at a time – it’s difficult to feel that you’re making progress when you can’t see the tangible results of your efforts.

So, in reality your disposable income isn’t “extra” money…it has a purpose and a place to go. In order to succeed financially, you must properly come up with a plan and a place to spend this “extra” money that tends to find itself being unaccounted for.

Before I go further, I want to preface what follows with an important statement: I am a major Dave Ramsey fan, but frankly there are too many people that eat too much ‘Dave Ramsey pie’ (as I like to call it). His philosophy is great, but the Baby Steps are very black and white. As an advisor/coach we’ve been trained to coach in the gray. (I’m going to have a follow-up post in a couple weeks about ‘eating too much Dave Ramsey pie’ – stay tuned.)

Assuming your budget is positive, here is what you should do with your disposable income:

1. Build a small Emergency Fund

Back in the 3rd part of this series, Budget Busters – discovering the traps in your budget, I wrote about (3) bank accounts that everybody should have.

Well, your 3rd bank account is specifically for building an Emergency Fund. Notice I said BANK ACCOUNT. Your emergency fund should be kept safe of market and any other risk that comes with investments. It’s best to have this money in a savings or money market account.

As you’re getting started on your financial journey, it’s important that you have some sort of savings set aside for rainy days. I typically suggest anywhere from $500-$5000. Where you fall within that spectrum will be up to your wisdom and better judgment.

This small emergency fund shouldn’t take years to build. It must be something that you can accomplish in a relatively short amount of time (say 3-6 months). It’s important to note that the dollar figure may seem small to some for an emergency savings account, but this isn’t intended to be all of your savings.

It’s just all of your savings that you’ll have for now as you’re working to build a solid financial foundation and get yourself out of debt.

Lastly, if you start saving for the non-monthly expenses that I mentioned in Part 3 of this series, then I’ve found that you’re going to have very little need for the emergency fund.

The small Emergency Fund’s purpose is to cover most emergencies: hospital bills, major car repairs that you can’t cover with your non-monthly account, and maybe even 1 month of going without a job. All other things people consider “emergencies” are covered in your non-monthly expenses.


After you’ve built your starter emergency fund, then it’s time to focus on paying off your debt. At this step, ALL of your disposable income should be going to attacking your debt and getting it out of your life forever!

The only debt that really isn’t included in this step is your mortgage, some LARGE student loans, and large home equity loans.

Dave Ramsey discusses using the “debt snowball” method. Using this method simply means that you pay your debts from smallest to largest.

For instance: after you’ve knocked out a small debt with say a minimum monthly payment of $50, that $50 doesn’t get added back into a spending category within your budget; that $50 now will be added to your monthly disposable income and will be used to help attack the next debt in line.

There are two things I want to address here:

(1) Ignore interest rates. I know we all want to work through our debt in an intelligent manner, and paying the highest interest-bearing debt is logical. But what I’ve found through coaching and personal experience is that WINNING is the most important part of this process.

If you attack a larger debt because it has high interest, it’s going to take you a LONG time to pay it off. You’re going to feel defeated and fall back into old habits because you aren’t able to see the light at the end of the tunnel.

Instead, focus on the smallest debts and pay them off first. This practice gives you tangible results and allows you to see real progress.

Now, I will add that if you have a debt that is $5000 (with a 5% interest rate) and one that is $6000 (with a 10% interest rate), then just go ahead and attack the $6000 debt. I personally believe that if they’re that close in dollar value then it’s wisest to pay the higher-interest debt.

(2) Too Much Dave Ramsey Pie. For the first 4 years of our personal journey, I ate a lot of Dave Ramsey pie. I mean…come on, I loved it! I was making progress, following the Baby Steps to the tee and knocking out debts left and right.

We built our starter emergency fund and for 3 years focused all of our disposable income on attacking our debts.

Instead of taking a step back and thinking for myself, I just kept plowing along. Then, much to our demise, I woke up one day and realized that I didn’t have any money saved. Our cars were breaking down left and right, and life started to happen.

Dave Ramsey’s steps are great, but you must be wise and think on your own. For instance, I’ve heard Dave tell a caller that had $90,000 of debt to not save for a car and only focus on paying down the debt. Well, this caller made $60,000 a year and had 3 kids and a wife that stayed at home.

I’ve done this long enough to know that that man would have been paying down his debt for 7-10 years without setting any money aside for a rainy day. Is that smart?


Do you think the chances of “life happening” over a 7-10 year period are likely? I would say so.

Modified Step 2

If you have a lot of debt (cars, credit cards, student loans, medical bills, etc), then I suggest you take two to three years and focus all of your efforts on paying down the debt. Assuming you have your small emergency fund in place.

After that 2-3 year period is over, you must be wise and start to plan for other things. I suggest dividing your disposable income up into percentages as followed: XX% to debt, XX% to emergency fund savings/personal goal/retirement/lifestyle increase.

I know you probably want me to tell you what to do exactly, but I’m a believer on educating. You must understand the principle and use your best discernment on how to divvy up those percentages. I won’t use specific numbers, but we personally decided on 30% will go to debt and 70% will go towards a few other things.

FINAL NOTE: If you find yourself unable to get out of debt within 2-3 years, and then you use the modified step 2 as I suggest, then you must mentally get in the mindset that your debt will be around for a little while longer.

That is okay…as long as you’re able to handle that. We added two years to our ‘get out of debt’ plan due to the modified step. Adding two years onto 5 wasn’t a big deal to me, because I knew I was being wise and planning for other things that are going to happen in the coming years.

3. Build Your Emergency Fund to 3-6 Months Worth of Living Expenses

I coach some people that like to have 3-6 months of income, but it really just depends on how conservative you are.

This step involves going back your small emergency fund you created in step one, and really building it up!

The important part here is that you have a limit in mind and don’t exceed it. I’ve seen far too many people have MASSIVE amounts of money in cash and they’re not using the majority of that money to work for them.

If you’re not outpacing inflation with a majority of your assets, then you’re losing ground.

There is no real reason to have any more than 6 months worth of living expenses (or income) in cash that isn’t earning much.

4. Save for Retirement!

Now that most of your debt is gone (if not all of it) and you also have a well-established emergency fund, it’s time to start saving and planning for the latter part of your life.

Dave Ramsey suggests putting 15% of your income into retirement savings, but I don’t think a specific percentage works for every situation.

The investment advisor in me knows that EVERYBODY must do their own retirement projections to determine how much YOU, specifically, need to be saving for retirement.

If you started saving early, then you may not need as high of a percentage. However, if you’re in your 30s, 40s, or 50s and haven’t taken retirement investing seriously, then 15% of your income may very well be too low.

Over 50% of Americans have never thought about or calculated how much they’re going to need in retirement.

Don’t be a part of the statistic. Be smart…find out how much you’re going to need and then determine how much you should be saving to get there. Don’t forget to include inflation in the calculation.

5. Kid’s College Savings

I put this in here for two reason: (1) because it’s a part of Dave Ramsey’s baby steps and (2) because I see WAY TOO MANY PEOPLE save for their children’s college but not for their own retirement.

I’ve met with people that were proud they paid for their children’s college, but at age 62 they didn’t have any money to retire.

Who do you think will bear the responsibility of taking care of you in retirement if you’re unable to do it yourself? Your children and the government.

If you have the financial ability to save for your retirement and also help your kids through college, then you certainly should do so if you’d like.

If you’re like most people and have to choose between the two, please choose to save for your retirement.

It will cost your children more to take care of you then it would for them to cover their own college expenses.

6. Pay off Your House

I’ve run into numerous people that don’t believe in paying their house off…and I’m not sure why.

Some ignorant people will argue and fight with me because they believe that having the interest deduction is a BIG DEAL. Unfortunately, they’re mistaken.

If you pay $5,000/yr in interest to the bank, that means you get to deduct that amount from your taxes (for now). Well, if you’re in the 25% tax bracket, that would mean you’re going to get back $1,250!

So, you pay the bank $5k to get back 1/4 of that? Why not just pay off the house and save the $5,000? You’re going to come out, mathematically, $3,750 ahead.

Get the house paid off. Don’t be like most people and refinance when they’re in their 50s and 60s. You don’t want a house payment when you get to retirement! Medicare and Long-term care insurance is going to cost you enough, and if you have a mortgage it’s likely you won’t be able to afford it all.

7. Build Wealth and GIVE, GIVE, GIVE

By this time in your life, you will have no debt (house included) and you’ll have a major amount of cash sitting in an emergency fund.

All that’s left to do is give, live life, build wealth, and give some more.

Final Notes

As you get started on your financial journey, you’re going to be on steps 1, 2, and 3 for a long time.

I encourage you to remember to take things one step at a time. If you’re making progress on a monthly basis, and you’re not going backwards (going into debt) or staying in the same position, then you’re eventually going to get there. Some things are simply a matter of time.

Just keep working at it and never give up!

Lastly, if you find a time in your life where you’ve gone back into debt, or you’ve had to use some of your small/full emergency fund, then you must go back to those steps and complete them before moving on. For example, if your small emergency fund is $1000 and you had to use $200 of it, then stop focusing on the debt and go back and build the emergency fund back to $1000.

Picture by Michal Marcol.

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About the Author

By , on Feb 9, 2012
Andy Tenton
Andy is a 30-something New Yorker who turned his financial life around. He took charge of his finances, got out of debt, and is now working his way toward financial success. He is the publisher of WorkSaveLive.com.

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  1. Mary says:

    Hi Andy,

    So far we are on track. Me and hubby have made some grave mistakes and now at 48 and 50 we have awaken our financial senses and we are ready to rock and roll the “DEBT” away and plan for retirement.

    1st Huge mistake-being proud of college debt for our daughter. We borrowed from Salliemae and borrowed more than needed so she would have living expenses…parents, DON’T DO IT!!!! We should have kept her in the dorm for 4 years and held her accountable for the “Party funds”. WOW, why did we ever do this.

    In 2006 I lost my great salary. I returned to college to retrain…graduated in Dec of 2011. Got a job Jan 30th (2012). Hooray-not receiving the salary from my last job, but that will grow as I further my education. I start graduate school in May of 2012. I will work on our debt vs disposable income on next week when I get free time.

    our debt is “:HIGH”. We have a debt free plan that started in October of 2011. Our total debt including the college loan, house, condo (being rented out), home equity, credit card, 3 small charge card accounts, and car note =’s $297,000.00. Yes, High as the sky, but doable to decrease. 🙂

    Our goal is 5 years for all debt “wiped out”. Our home is on a 15 yr mortgage, we will be at the 10 yr mark in 2013. We plan to refinance. I am praying that the economy interest rates will continue through our desired time frame.

    our net income (after taxes) monthly is approx: $8212.00

    We have a 401 K investing at 6% with company match. Due to new employment my 401-K will not start for 90 days. We have other low risk investments.

    Thank you for sharing. Our immediate need, according to your above post, is to start on our emergency fund. Currently there is $216.00 in this fund. We have savings/money market account.

    We do plan to take the disposable “extra” income and start splitting between the 3 credit card accounts and the emergency fund until it reaches, per your post, $5000.00 over a 3-6 month period. May 30th is our goal.

    Well I welcome any recommenations.

    Thank you for sharing, I appreciate it immensely!! MBR

    • Andy says:

      Hi Mary!

      I really appreciate your comment and sharing your story!! I will send you an email in response. I’m curious if I can use this scenario and respond to it as a blog post.

      Have a great day!

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