How to Calculate Your Savings Rate

Knowing how much you spend is critical to knowing how much you need to save.

Your savings rate is the percentage of your income that you save each month, and it’s a key indicator of your financial health. In this post, we’ll break down the importance of savings rates, how to calculate yours, and provide tips on how to improve it.

Why Your Savings Rate Matters

Your savings rate is a critical component of your financial plan, as it determines how much you’ll have available for long-term investments, emergency funds, and big-ticket purchases. A high savings rate can help you:

• Build wealth: By saving a significant portion of your income, you’ll be able to invest in assets that generate passive income, such as stocks, real estate, or bonds.
• Achieve financial independence: Saving aggressively can help you retire early, pursue your passions, or simply enjoy a more comfortable lifestyle.
• Weather financial storms: A robust emergency fund can provide peace of mind and protect you from unexpected expenses, job loss, or medical emergencies.

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How to Calculate Your Savings Rate

Calculating your savings rate is straightforward:

1. Determine your net income: Start by calculating your take-home pay, which is your gross income minus taxes, deductions, and other withholdings using an app like Simplifi.
2. Track your expenses: For one month, write down every single transaction, including small purchases like coffee or snacks. This will help you identify areas where you can cut back.
3. Calculate your savings: Subtract your total expenses from your net income. This will give you your total savings for the month.
4. Divide by your net income: Divide your total savings by your net income, then multiply by 100 to get your savings rate as a percentage.

Example:

Let’s say your net income is $4,000 per month, and you’ve tracked your expenses to be $3,200. Your total savings would be $800 ($4,000 – $3,200). To calculate your savings rate, divide $800 by $4,000, then multiply by 100: (800 ÷ 4000) x 100 = 20%.

Net income or gross income? Pick one and stay consistent

The example above uses net income, take-home pay after taxes and deductions. Many early-retirement communities divide by gross income, which always produces a lower number. Neither is wrong, but switching makes your rate meaningless; pick one and use it every month.

If you use gross, decide up front whether employer 401(k) contributions and matches count as income; standard approach treats pre-tax 401(k) contributions as both income and savings. If you just want a number to watch, net income is simpler and harder to game.

What counts as savings

A dollar saved is any dollar that increases your net worth that month: cash saved; retirement contributions (401(k), IRA, HSA, including employer match); debt principal payments (principal counts, interest does not); brokerage and HSA contributions.

Do not double count: a $500 401(k) payroll contribution is savings once, not an expense.

Tips to Improve Your Savings Rate

• Create a budget: Allocate your income into categories, prioritizing fixed expenses like rent/mortgage, utilities, and food.
• Cut back on discretionary spending: Identify areas where you can reduce spending, such as dining out or subscription services.
• Automate your savings: Set up automatic transfers from your checking account to your savings or investment accounts.
• Take advantage of employer matching: If your employer offers a 401(k) or other retirement plan matching program, contribute enough to maximize the match.
• Consider a savings challenge: Try a savings challenge like the “52-week savings challenge” where you save an amount equal to the number of the week (e.g., Week 1: Save $1, Week 2: Save $2 etc.).

Calculating your savings rate is a crucial step towards achieving financial freedom. By understanding your savings rate, you’ll be able to identify areas for improvement, create a budget, and make progress towards your long-term financial goals. Stay tuned for more personal finance tips and tricks to help you on your journey to financial independence.