What Is Your Savings Rate?
Your 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, your emergency fund, or any other financial goals you might have.
Why Is Your Savings Rate Important?
Your savings rate is arguably one of the most important components of your financial plan. It’s also what you have the most control over. You don’t have control over the market returns 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 one of the biggest impacts when determining if you will have enough money to last through your retirement years. The higher your savings rate towards retirement, the better your overall financial progress will be. That means you’ll either be able to retire earlier or have more money during your retirement. Maybe even both.
How To Calculate Your Savings Rate
Savings rate can be calculated by dividing your monthly savings amount 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.
An Example of Calculating Savings Rate
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 down payment on a home one day.
Here is how we would calculate their savings rate:
From the example above, Jake and Mylie have a retirement savings rate of 15%. Their 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.
General Savings Rate Recommendations
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. The amount of years you are able to save for retirement has a big impact);
- The second is how much you want to have when you retire. This comes down to the lifestyle you want to live during your retirement.
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. Keep in mind that the amount you are saving depends on your current age.
Here are a few 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 would normally continue, but we have abbreviated it to show you the important information. As you can see, the fewer years that you have left to save for retirement while working, the more you have to save.
Alternatively, the image below will show you how much money you need to be saving, starting at what age, to reach a million dollars in total savings.
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. Finding areas you can cut down on means that you have opportunities to 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. 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 a great way to save more money. This way you don’t have to hurt your current lifestyle, but you can still save more.
When you increase your 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. When this happens, it usually 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.
There are quite a few ways that you can increase the amount you are earning:
- Having a side hustle
- Getting a new position (with your current or a new employer)
- Negotiating a raise
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. For more information on income, check out our income guide as a resource to help you navigate ways to improving it.
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.
Improving Your Savings Rate
As you can see your monthly savings rate is very important when it comes to reaching your goals. This is why increasing your savings rate is one of the key recommendations you will find in your financial plan. Your Savology financial plan is able to tell you how much you need to increase your savings rate by in order to reach your desired retirement outcome. If you haven’t created your free financial plan yet, get started right now to see if you are saving enough to reach your retirement goals.