Tracking your Savings Rate is a hotly contested topic in the personal finance space, the arguments have escalated beyond polite disagreement (barely). Which for PF bloggers is the equivalent of a bare-knuckle boxing cage match with no rules against crotch shots.
Personally, I love using a savings rate. It shows how you are allocating your income and is one of my preferred goal setting metrics. I equate it to a collection of all the individual goals we set each year in one number that we have control over (unlike Net Worth which can be manipulated by the stock market).
When are they not useful?
When you try to compare yourself to others, especially if you use different formulas to arrive at the rate. They should be used to track YOUR performance over time, not to crush the spirit of someone who isn’t saving “enough”
That being said, I have found motivation looking at particularly high savings rates (40%+). The process looked a something like this:
- How and why the F are they saving so much, I thought saving 10% was the gold standard
- Holy balls, what is Financial Independence/Early Retirement
- I want some of that, how can I make this happen
- Dozens and dozens of small changes
- 2 to 3 years later, holy shit we are actually doing this
If you can’t tell, I jump into things with an open mind and when I see something that interests me I don’t let it go easily. 3ish years later I am writing about Financial Independence and looking for any opportunity to shorten our path.
My love stretches beyond just motivation though, we use our Savings Rate as a budget (Because Budgets Suck, we failed at them, multiple times). Once we hit our goal, everything left is guilt free spend.
Different Flavors of the Savings Rate
Before going through all the different ways I have seen people track their savings rates, I need to clarify that “savings” means more than stacking money in a savings account earning .05% interest. It definitely includes money you invest, and beyond an emergency fund that is exactly what you should be doing.
I don’t include funds being saved for a future purchase however as they have an expiration date that does not equal your FI date and the cash won’t be working for you later.
Below are 4 methods I have seen used to calculate your savings rate.
Straight Percentage of Income
The Easiest way to track your savings rate is to take how much you are saving divided by your income. Since we should already have numbers for income and savings/investing, this will be a straightforward calculation later.
If you don’t have this info – check out this FI Action Series Post (What is your Financial Position Today)
After-Tax Savings Rate
This is my preferred method of tracking our savings rate. I like to look at the money we have control over….AKA not money that I am required to pay to the Gov.
This one is a little more difficult in you need to have a pretty good idea how much you will be paying in taxes (your pay stub is a good resource) or the rate you will most likely be paying for the year. I use our paycheck and adjust based on our previous year’s taxes to get as close as possible.
I added a tax section on the income tab of the FI Action Spreadsheet to be used in this calculation later.
Count Debt Principal Pay-Down
This method builds on of either of the previous options but you also add in any principal debt pay down in the calculation. I have seen this done 2 ways:
- All principal reduction (monthly mandatory payments and extra payments)
- Only extra payments that reduce the principal balance
I like that it gives you an overall picture of how you are improving your financial situation. But, I think the better test is what you do with that money after you pay off your debt and that is why I don’t include it in our savings rate. If all goes according to plan, money that used to go to debt will go to our investment accounts.
Action Item: Don’t let me sway you on which one of these is the “best” option. This is how YOU are going to track your savings rate. What are you most likely to maintain? Which one will keep you motivated?
Calculating your Savings Rate
Now that the options are laid out, its time to set the baseline. Thankfully, we did a lot of the legwork to calculate this already, cracking open the FI Action Series Template here are the 4 options highlighted above and the formula for each
- Using Total Income (Savings and Investments / Income)
- After-Tax Income (Savings and Investments / (Income X Tax Rate))
- Including Principal Paydown, Total Income (Savings and Investments + Principal Pay down /Income)
- Including Principal Paydown, After-Tax Income (Savings and Investments + Principal Pay down / (Income x Tax Rate))
If you select an After-Tax method you will need to enter your taxes on the Income tab. If you are including Principal Paydown in your calculation add it to the column on the Savings Rate section. Everything should calculate automatically.
Action Item: Calculate your Savings Rate using the FI Action Series Template (savings tab)
Where do we go from here?
There is one more metric I want to set the baseline for, and its a biggie! Your Net Worth should be tracked along with everything else we have covered and that will be the next section in the FI Action Series. From there we are going to one of my favorite topics (Goal Setting).