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How To Calculate Your Savings Rate

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When starting your Financial Independence (or “FI”) journey, one of the first concepts you’ll come across is “savings rate.” You may be wondering what that is and how to calculate your own.

To calculate your savings rate, divide your savings by your income and you get the percentage of income you save. Or written another way: Savings / Income = % Savings Rate

However, there is no black and white way to do it. While it’s an easy concept on the surface, once you dig into the details you’re going to have to make personal decisions. Specifically on what you do and don’t want to include when calculating your savings rate.

Why Do You Need To Calculate Your Savings Rate?

If you’ve been hanging around the FI community, chances are you’ve heard people quoting their savings rates. Why? Your savings rate can allow you to calculate how many years until you reach Financial Independence.

The basic idea is that the more of your income that you can save, the sooner you’ll be able to retire. Logical, right? Let’s see an example.

If you are starting from 0 and save 15% of your income you will be FI in 43 years. However, if you can bump that up to 20% you’ll be FI in 37 years–shaving 6 years off your career. Get that up to the coveted 50% savings rate and you’ll be free of having to work in just 17 years.

So you can see why we love to discuss (and compare) savings rates. It controls our timeline to freedom.

The Basics of Calculating Your Savings Rate

Calculating your savings rate is simple until you start trying to define the components. These components are your income and your savings. To calculate your savings rate, divide your savings by your income and you get the percentage of income you save.

Easy, right? Well, how do you define income? Is it gross income? Net income? If it’s net income, how do you calculate your net income? We’ll get into all of that in a minute. But first, let’s explore why savings rate is so important.

How Your Savings Rate Can Predict Financial Independence

Your savings rate can predict your FI date if you plug a few numbers into a calculator. Assuming you start with a net worth of 0, the years until you reach FI can be summed up perfectly by a chart in this popular Mr. Money Mustache post.

This chart makes some assumptions including what your rate of return on your investments will be after inflation (3-5% is assumed) and your withdrawal rate in retirement (4% is assumed). Income is defined as gross income minus all taxes paid. Savings is defined as all money you’re saving for FI.

Based on these assumptions, a savings rate of 5% will result in 66 years until you have enough money to reach FI. On the other hand, a 25% savings rate shrinks that time to 32 years. A 50% savings rate shortens the time to 17 years. And 75% savings rate slashes your time until FI to just seven years.

Listen: How To Calculate Your Savings Rate

This Is Where Personal Finance Gets “Personal”

How you decide to calculate your savings rate is up to you. The chart Mr. Money Mustache shares is great for a general rule of thumb. However, if you want to more accurately predict how soon you’ll reach FI, you’ll have to use a more detailed calculator. 

For instance, very few people start their FI journey with a net worth of 0. Either people are in debt or they have a positive net worth due to their previous savings.

Let’s explore different ways you can calculate your income and ways you can calculate your savings. Pick the methodology you’re most comfortable with or create your own to measure your personal savings rate.

How To Define Income

How you define your income is important when calculating your savings rate. Because it indirectly defines the a very important part of FI: how much you spend each year. After all, you either spend or save your income. If you know how much you save, you can then calculate how much you spend.

Spending is very important because that’s what most people use to calculate how large their investments need to be to reach FI. Simply multiply annual spending by 25 to get your FI number (assuming a 4% withdrawal rate).

How do you calculate income? Some people use gross income, which is your income before any expenses or taxes are taken out of your paycheck. This is also likely your salary if you have no side income.

Others prefer to use net income. You could make it easy on yourself and calculate your net income as the amount you’re paid each pay period. Keep in mind, you’ll still have to make some adjustments such as adding your 401(k) contributions back to your income–and maybe your company match as well, if you want to include the match in your savings amount.

You’d also be leaving some important expenses out of the cost of living side of the equation if you have benefits like health insurance taken out of your paycheck.

Related: Beyond 4%: The Argument For Flexible Spending Rules In Retirement

Defining Personal Savings

Defining savings isn’t easy either. While you could simply add up all the money you set aside for FI, there are more complex alternatives that could give you a better grip on your true savings.

First, add up all the money you save or contribute to a retirement account that you don’t plan to touch until you reach Financial Independence. This includes savings accounts, taxable investment accounts, tax-advantaged accounts, health savings accounts, and retirement accounts like 401(k)s, IRAs and their Roth counterparts.

Next, you may decide to add in any employer match or employer contributions you receive for retirement accounts or health savings accounts since that money can be used to help fund your FI goal. If you do this, consider adding the same amount to your income to level out the effect it could have.

A simple example: let’s say you are a couple and have a household income of $50,000. As a couple you save $25,000 into your 401(k)s. You’d be saving 50% of your income. If your employer is contributing $5,000 per year to your 401(k) and you count that in your savings rate, you are now saving 60% of your income.

If you also add the $5,000 of your employer contribution to your income, now your savings rate is 54.5%. Which is actually the most accurate.

Finally, you may even want to consider adding in the portion of your mortgage payment that goes toward principal each month. This addition could be considered a bit aggressive, but you are growing your net worth when you make your mortgage payment each month. Will your home’s value grow at an assumed 5% rate of return after inflation? Probably not. But it does increase available assets if you decide to downsize your home in the future or sell your home and rent, instead.

Related: Should You Pay Off Your Mortgage Or Invest

Calculate Your Own Savings Rate

After you decide how to define income and how to define savings, all you have to do is take your savings and divide it by your income to get your savings rate. Use that information for whatever you’d like, but if you want a true approximation of when you’ll reach FI, we highly suggest seeking out a detailed calculator or creating your own.

How do you calculate your savings rate? How do you define income and expenses? We’re interested to hear what you have to say and if you’d like to share what your savings rate is. Join the conversation in the ChooseFI Facebook group or leave a comment below.

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Choose FI has partnered with CardRatings for our coverage of credit card products. Choose FI and CardRatings may receive a commission from card issuers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities. Disclosures.
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