Savings Rate: How to Calculate It and Why It’s Important

Do you know what your savings rate is?

If not, it’s time to calculate it!

Your personal savings rate is a key number that tells you how much of your monthly income you’re saving.

Knowing your savings rate can help you make informed decisions about your money and reach help you hit your financial goals faster.

So, let’s take a closer look at how to calculate your savings rate and why it’s important.

Why Your Savings Rate and Saving Money is Important

Saving money is essential for anyone who wants to achieve their financial goals or retire.

Because retirement isn’t an age, it’s an amount of money. And once you have 25x your annual spending invested, you can retire, no matter how old you are!

With a high savings rate, you can put away enough cash to cover your expenses for years before your mid to late 60s.

Once you have 25x what you spend annually invested, according to the 4% rule, you shouldn’t run out of money.

The Benefits of Saving Money

Pay Off Debt:

Debt is expensive. When you owe money, interest charges eat away at your savings. By saving and paying off debt, you reduce the interest you pay over time.

Build Wealth:

You can build wealth over time by investing in stocks and bonds. But, you also need to save money to invest. And, you can only invest money you’ve saved.

Create Financial Stability:

Financial stability is essential for everyone. Having some cash aside gives you peace of mind knowing you won’t run out of money when emergencies happen.

Protect Yourself Against Losses:

Shit happens. From medical costs, job loss, car repairs, etc. Having extra money stashed away allows you to protect yourself against these losses.

How to Calculate Your Savings Rate

To understand how much you save each month, you need to learn how to calculate your savings rate.

Luckily, there are some easy and not too complicated ways to calculate your savings rate.

But it’s as simple as this: Savings/Income = Savings Rate

The first thing you need to do is figure out what your total monthly income is. Your monthly income should include your salary and any bonuses or other compensation.

Next, divide your monthly savings amount by the sum of your monthly gross income. Then multiply that number by 100 to get your savings rate.

For example, let’s say you make $4,500 per month and you’ve saved $1,200 consistently every month; then, in this case, your savings rate is 26% per month.

Why Calculate Your Saving Rate by Gross Income vs. Net Income?

You may have heard that saving money is important. But did you know it’s important to calculate your savings rate by gross income instead of net income?

Net income is the amount of money left over after taxes and deductions. For example, you make $50,000 annually and pay $7,500 in federal tax. Your net income is $42,500.

Gross income is the total amount of money earned before taxes and deductions. So, for example, if you made $50,000 last year and paid $7,500 in taxes, your gross income would still be $50,000.

Now, let’s assume I save 26% every month throughout the year from my NET salary. How much money would I have saved?

$3,550.666 x 26/100, which gives $910 every month.

So, you would have saved $10,920 in just 12 months!

Let’s look at another scenario if I’m saving from my GROSS income.

Let’s say I’m saving the same 26% but from my annual gross every month. What would happen?

$4,166 x 26/100, which gives you $1083 every month

So, I would have saved $12,996 in just 12 months!

In this case, I would have saved more. Why? Because I’m saving from my total money without any deductions.

This is why it’s important to calculate your savings rates by gross income instead of by net income. By doing so, you’ll save more money than if you were calculating your net income.

How Does Savings Rate Affect Financial Independence Timeline?

Have you ever wondered when you’ll reach financial independence? How much money you’ll need to retire? Or ask yourself if your retirement savings will be enough before your kids graduate college. 

Your savings rate is a key indicator of how much money you’ll need to retire.

Let’s say I’m living from paycheck to paycheck. Living like this isn’t necessarily a bad situation because I might be able to pay down debt, save money, and live comfortably without worrying about retirement.

However, if I don’t start saving now, I might not be able to retire as fast as I want.

Here’s questions to ask yourself to know how your saving rate can influence your ability to achieve financial independence:

• How Much Money Do I Need to Retire? Many retirees rely on Social Security benefits alone to support themselves in retirement. However, according to the U.S. Census Bureau, only about half of all households headed by people 65 years old or older receive Social Security benefits.
  
  The remaining households supplement their income with private pensions, personal investments, and government assistance.
  
  For those who plan to rely only on Social Security, the monthly benefit amount depends on several factors, including the number of months until retirement, the current age of the recipient, and the recipient’s earnings history.
  
• What Is My Current Savings Rate? Your savings rate is the percentage of your gross annual salary that goes toward saving. Let’s say you make $50,000 per year and spend $20,000 per year on living expenses. Your savings rate is 60%.
  
• How Can I Improve My Savings Rate? You can boost your savings rate by increasing your contributions to your 401(k), IRA, or other qualified retirement plans. The average American worker contributes only 3.7% of their paycheck to these plans.
  
  Another way to save more is to cut back on unnecessary spending. Many experts recommend setting aside 15% of your income for discretionary purchases like dining out, entertainment, clothing, and household items.
  
• How Long Will It Take Me to Reach Financial Independence? Financial independence means you have enough money to cover basic living costs throughout retirement.

The good news is that there are many ways to determine how long it will take you to reach financial independence. One method is to use an online savings rate calculator such as this one from Fidelity.

Another option is using a spreadsheet program like Microsoft Excel to determine your savings rate.

Both ways require you to input information about your current age, expected future salary, desired retirement date, and current savings rate. After entering these numbers in the calculator or spreadsheet, you’ll get a rough estimate of how much money you’ll need.

How Your Savings Rate Can Predict Financial Independence

A specific financial goal among millennials is retirement.

They want to save enough money to live comfortably during their golden years without worrying about where their next meal will come from. But according to recent research, most people aren’t saving nearly enough.

A study by Bankrate found Americans aren’t saving enough to meet their long-term goals.

The good news is that there are many ways to increase your savings rate. And while some require significant lifestyle changes, others involve making a few minor adjustments.

Here are three tips to help you start building up your savings accounts:

1. Make Saving Your Top Priority

Most people probably don’t prioritize saving over spending.

After all, what’s the harm in blowing $100 on lunch today? Well.. if I spend too much now and can’t pay for it, I’ll pay interest on the purchases later.

But if I want to become financially independent, I’ll have to put my savings rate and annual savings ahead of everything else.

2. Set Up Automatic Transfers

One way I ensure I’m regularly depositing extra cash into my savings account is to set up automatic transfers. This process involves transferring funds from my checking account to my monthly savings account.

For example, if you start working when you’re 20 years old and transfer $500 per month for 40 years, you’ll have saved $240k by the time you turn 60.

3. Live Below Your Means

While it may seem counterintuitive, living below your means increases your savings rate.

The reason is simple — when you’re broke, you can’t afford to splurge on things like eating out or buying new clothes.

Instead, you have to make do with what you already have. As a result, you’ll likely find yourself putting away more money than usual.

And remember, no matter how hard you try, you won’t be able to build a significant nest egg overnight. While it might take several years to reach financial independence, the sooner you get started, the better off you’ll be down the road.

General Savings Rate Recommendations

Financial experts recommend setting aside at least 15% of your monthly income.

This amount may vary depending on how long you plan to work, your career path, and whether you’re married or plan on having kids. And if you do, it’s crucial to factor in child care costs into your budget.

You’ll need enough money saved up to cover your living expenses during retirement.

For example, if you want to travel the world, you might need $1 million. But if you plan on spending your days relaxing, your expenses should be lower than $ 1 million.

Why It’s Never Too Early to Start Saving for Retirement

We should all strive to increase our total income by saving money and increasing our total income.

But when it comes to retirement planning, saving as much as possible early on is essential. You only have so much time before retiring, but you still have plenty of years to save.

Starting early gives you the best chance to build wealth over the next several decades.

By investing regularly throughout your life, you can maximize your returns. As you invest, you’ll likely earn interest on your savings and compound that interest over time.

So, instead of relying on Social Security benefits alone, you’ll also be able to supplement your income with investments and retirement accounts.

Retirement is supposed to be a time of leisure and relaxation.

However, many are living paycheck to paycheck right now and in retirement without a single retirement account. This can lead to a lot of stress and anxiety.

I don’t want that to be me, having to worry about making ends meet every month. Nope, I want to focus on enjoying life.

With a nest egg, you nor I will have to worry about running out of money during retirement. We’ll have the freedom to travel, spend time with our loved ones, and pursue hobbies.

Savings Rates and The Case for Passive Income

Passive income is simply money that flows into your bank account without requiring much effort on your part. For example, let’s say you decide to write a book.

You’ll receive royalties when you publish your book whenever someone buys a copy. These royalties will flow directly into your bank account.

In addition to saving more money, passive income also allows you to diversify your sources of income. When you invest in stocks, bonds, mutual funds, etc., you’re essentially putting your money into something that generates revenue over time. 

With passive income, you’re earning money in your sleep.

Another benefit of passive income is that it provides a steady cash flow. As opposed to relying on sporadic earnings from your job, passive income offers consistent monthly payments.

Having a source of passive income can reduce the amount of money you need to save for retirement.

For example, you might have REITs that bring in monthly income. Or you might have invested in a business that generates revenue without your day-to-day involvement.

If you have a reliable source of passive income, you’ll have an extra stream of income to help cover your living expenses in retirement.

This can allow you to reduce your savings rate and still have enough money to live comfortably.

In addition, having passive income can help diversify your retirement income sources and make your finances more stable. So if you’re looking for ways to reduce your retirement costs, consider pursuing some form of passive income.