As I have mentioned in previous posts, I did not start out making great money when I graduated from college, I was saving next to nothing and primarily paying off my student loans (Student Loans – Accumulation). My savings rate was under 5% and I was well into the negative net worth category (-90K+ without a mortgage). Over the last 4.5 years our savings rate has drastically increased (over 30%) and we have completely flipped our net worth.
Savings Rate – Defined
Savings rate can be simply defined as the percentage of after tax income you save or invest – count contributions to your 401K, Roth IRA, Emergency Fund, Savings Account, or any other investment/savings vehicle. Some people include the amount of principal paid on their mortgage or student loan, I do not recommend including these since they are technically liabilities (and if you didn’t live in your home where would you live?). Paying off debt is improving your overall financial position, but the real test is whether you invest the payment after, versus spend it or acquire more debt.
There are multiple methods to calculate a savings rate – I prefer to use after tax (disposable) income since I do not have control over the tax bill.
Calculating Savings Rate
- Get your paystub or W2 if you want to calculate it off of last years total earnings
- Find your gross earnings and subtract the taxes taken out (add your employer match to your after tax income)
- Gather/write down all the accounts you put money into (yearly amount or percentage if it is a straight salary deduction)
- Add up all your savings/investment amounts (include employer match on 401K)
- Divide your savings by your after tax income (Ie. 5,000 Savings / 50,000 after tax income = .10 or 10%)
I created a spreadsheet to help you calculate your savings rate, you can download it at the bottom of the page.
Increasing your savings rate
After calculating your savings rate, evaluate where you are and where you want to be then start working on your plan for the next 12 months. Somethings to consider:
- Reduce spending – seeing the % of disposable you save/invest automatically gives you the % you spend, you can do some quick math and subtract out your fixed payments (home, insurance, groceries, auto loans, etc) and see how much money you are spending outside of ‘necessities’
- Increase your income (see below) – Create a new revenue stream or work towards a promotion and use the proceeds to boost your savings rate
- Incrementally increase automatic withdrawal – Last year we increased our 401K contribution on a quarterly basis – we didn’t start to feel any pain until the end of the year. Start small and work your way up.
- Find new investment opportunities- There is something about finding a new investment that motivates me to ‘find’ additional money (found money probably = reducing spending at this point)
The easiest way to increase your savings rate is to take advantage of raises
After Tax Income – 100,000
Savings Rate – 10% ($5,000)
Raise – $5,000
New Income – $105,000 if you were doing a 10% automatic investment, you would now be saving $10,500, but you would have $4,500 more than you previously had as disposable income. Since you are used to living on less, use this as an opportunity to bump up your savings rate. If you saved half (minimum I recommend) you would put an extra $2000 away every year and your savings rate would jump to 12%. You would still be able to increase your standard of living by $2,500.
How do you stack up to the rest of the country????? Most sites I check recommend having at least a 10% savings rate, that feels very low and someone who is reading personal finance blogs should strive to beat the amount recommended for average Americans. I think a reasonable (low-end) target for a professional would be around 20% – if you are well under that rate right now find ways to cut your spending and slowly increase the % via automatic deductions into investment accounts. Personally, I would like to compare myself to people in similar situations to see how I am tracking against my peers, but it is difficult to find exact data – check out the US rate……
US Personal Rate is at 5.50%
If you plan on retiring early, you will need to crank your savings rate to the 30-40% mark at least – think of it this way, if you can learn to live on less and save more, you are double stamping your savings.
Although I did not include this in my 2016 Financial Goals, your Savings Rate should be something you monitor at least twice a year. Every time we get a raise I usually re-check our savings rate to make sure we are keeping pace. Since we both recently got raises, I will calculate our new savings rate and add a 2016 financial goal below:
Amendment to 2016 Goals – increase savings rate to 35%
Calculator – Click here to download the Savings Rate Calculator
Gather everything you need and calculate your savings rate – use the spreadsheet if you need some help (let me know if you have any issues, I will correct and repost if needed). Compare yourself to the US Average – the recommended 10% – and what I recommend to see how you stack up. If you are under 20% come up with a plan to increase your savings rate over the next 12 months. Please post your rate and any other tips you have to increase it.