What Is Savings Rate?
Savings rate is the amount of money you save each month as a percentage of your total or gross income. The higher your savings rate, the more money you are saving per month. The more money you are saving each month, the more you can accumulate towards retirement, a down payment, an emergency fund, or any other goal.
Why Is It Important?
Savings rate is arguably one of the most important components of your financial plan. It is what you have the most control over. You don’t have control over your market return or how long you will live. While you can do things to influence these other factors, you have the most influence over your savings rate. Therefore, it can be said that your savings rate has the biggest impact on your financial planning and retirement success.
In Stephen Covey’s book, The Seven Habits of Highly Effective People, he talks about your circle of influence and the importance of focusing your efforts on your circle of influence. You have a significant influence on your savings rate through your ability to control expenses and increase your income. So if you focus on your savings rate instead of what the market is doing, then it will help maximize your success.
Your savings amount has the biggest impact when determining if you will have enough money to last through your retirement years. The higher your savings rate towards retirement, the earlier you can retire.
How To Calculate Your Savings Rate
Savings rate can be calculated by dividing your monthly savings amount divided by your monthly gross income. This can also be done by dividing your annual savings rate by your annual gross income. This gives you the percentage of your income that is going towards savings. Savings include retirement savings as well as other monthly savings. When doing the calculation on your own, be sure to include your employer contributions into a 401(k) or other retirement plan provided through your employer.
Why Gross Instead of Net income?
Gross income is used as the industry standard while calculating savings rate/ratio. This is because taxes can vary from household to household. Because of this, it can throw off how much it seems like you are saving. If you are in a high tax bracket then it may seem like you are doing better than you actually are. Gross income makes it a level playing field to see if you are saving the amount that you need to be.
Let’s say Jake & Mylie make $5,000 a month as a household, which is $60,000 per year. They consider themselves to be good savers. They save $550 a month towards retirement. They also save $200 into a savings account each month for a downpayment on a home one day.
Here is how we would calculate their savings rate:
The results would be the same if we calculated it on an annual basis, though it can occasionally be more difficult to approximate your annual savings.
Many personal finance experts recommend a flat savings rate of 15%. While that isn’t a horrible rule of thumb, it is important to note that it should vary more widely based on two primary factors. The first is when you start saving, and the second is how much you want to have when you retire.
The CFP Board makes even more specific recommendations for savings rates based on when you start saving.
If you start before the age of 32, CFP recommends a savings rate of 10 – 12% of your gross income. If you don’t start saving until you are 40, then the recommendation increases to 20-25% of your gross income.
If you want to retire before the general retirement age range of 65 to 70, or if you have other big goals then you will need to adjust these savings rates to save more or less depending on your goals and time frame. That is why it is important to get a personalized financial plan to help you to determine your recommended savings rate based on your own age and goals.
Impact of Savings Rate On Retirement
As we have already discussed, savings rate has a huge impact on your financial plan. The biggest impact on your projected retirement age is your savings rate. While rate of return and time are also important, savings rate is the most important of all. Here are some different scenarios to illustrate that fact. This illustration is from Mr. Money Mustache’s article called The Shockingly Simple Math of Early Retirement.
- You can earn 5% investment returns after inflation during your saving years
- You’ll live off of the “4% safe withdrawal rate” after retirement, with some flexibility in your spending during recessions.
- You want your “Stash” to last forever, so you’ll only be touching the gains, since this income may be sustaining you for seventy years or so. Think of this assumption as a generous safety margin.
Here’s how many years you will have to work for a range of possible savings rates, starting from a net worth of zero:
|Working Years Until Retirement||Saving Rate|
This chart normally continues, but for the sake of our younger readers, we have abbreviated it. As you can see, the fewer years that you have left to save for retirement while working, the more you have to save.
Ideas To Increase Savings Rate
Trim Your Spending
It is important to look over your budget and see where you can cut back on your expenses. Whenever you find some areas where you can cut your expenses, you can put that money towards saving more.
When it comes to cutting back your expenses, the first thing people often look at is discretionary expenses. While this can be a great place to cut back on your expenses, you may not be able to cut back too much here. Every dollar does count, especially when added up month after month, year after year. You should also look at your biggest expenses like your housing costs or vehicles, as changing spending in these areas can result in big wins and can have a huge impact on your overall financial savings.
Increase Your Income
Making more money is an awesome way to save more money. This way you don’t have to hurt your current lifestyle, but you can still save more. When you do get an increase in income, it is important to not have lifestyle creep. Lifestyle creep is when you increase the cost of your lifestyle as you make more money, which means you don’t end up getting ahead. When you earn more, it is okay to be intentional about spending more in certain areas, but if you take the majority of your increased earnings and put it towards savings then it is powerful. You are able to save more while maintaining the same lifestyle.
You can do this through having a side hustle, getting a new position, negotiating a raise, or getting a new job. These are all proven ways to increase your income. Your earning ability is your most important asset. If you are constantly finding ways to earn more you should have no problem getting to a healthy savings rate.
Pay Yourself First
It is important to pay yourself, or your goals, first and then live on the rest of your money. You can easily do this by setting up automation to transfer money into your savings or retirement accounts right after you are paid. This will ensure that you are streamlining the process and that you reach your goals.
As you can see your monthly savings rate is very important when it comes to reaching your goals. This is why Savology has it as a key recommendation in our financial plans to increase your savings rate. We can tell you how much you need to increase it by in order to retire when you want to. If you haven’t gotten a free financial plan, get one here to see if you are saving enough to reach your retirement goals.
Your financial future starts today
Savology is a free planning platform where you can build a free, unbiased, personalized financial plan in about 5 minutes. Your Savology plan will give you action items to start working on as well as an overview of your current financial situation. After you have made some progress, Savology can connect you with some of the world’s top providers to help you accomplish your financial goals.