Your Savings Rate: Your Ticket to Financial Independence

Your savings rate is the percent of your income that you save. Simple enough. But knowing your personal savings rate can help you understand how long it will take you to reach financial independence.

General budgeting advice recommends saving 20% of your monthly income. If you invested that 20%, earned the average market return during your working years, and accounted for inflation you could expect to be retired (or financially independent) after 37 years of work. (I plan on writing another post in the next few weeks, going into detail about some of the math behind this).

However, most people don’t hit that 20% mark. In 2019 the U.S. averaged a personal savings rate of 7.6%, which increases the years that one needs to work in order to hit financial independence. At the 7.6% savings rate, you can expect to work a total of 57 years — 20 more than at the recommended 20%.

Interestingly, during April 2020, in the middle of the country’s quarantine and the economy shutting down, the average U.S. personal savings rate hit an all-time high of 33% — shattering the previous record of 17.3% in May of 1975. People couldn’t go anywhere, stimulus checks and tax refunds hit many people’s accounts, and widespread economic uncertainty likely led many people to amp up their savings while they knew they had income.

The magic of understanding your savings rate comes from the fact that bumping up your personal savings rate by a few percentage points can shave years off of your required working years. Drastically increasing your personal savings rate can be life-changing.

Obviously, the amount of money that you make will affect how much you can increase your savings rate. After all, we all need to eat, clothe, and shelter ourselves and there’s only so little these basics can cost. But if you are someone making a decent salary, there are few reasons why you wouldn’t be able to drastically increase your savings rate while still living a really comfortable and fulfilling life.  

That’s why I believe that part of the problem with standard personal finance advice lies in the fact that we use these general percentages to cover folks making vastly different incomes. It seems ridiculous to me that we would recommend the same “save 20% of your income” to someone making $40K a year as someone making $80K a year.

I would argue that a single person can live a pretty comfortable life on $40K per year (if they don’t have children and live in a moderately priced market). If that’s true, then I would also argue that if that same person made $80K a year, they could still live that nice life on $40K and could save the other 50% of their income.

If you’re not making $80k per year, don’t be discouraged — neither do I. I make $43K a year, travel often, eat delicious food, donate regularly, generally want for nothing, and manage to save between 30-50% of my income any given month. How? Keep reading this blog to find out 👀

Saving 50% of your income is life-changing. If you save 50% of your income during your working career, it would only take you 17 years to reach financial independence. That’s 40 years less than the average person in the U.S. saving 7.6%.

This is because every percentage point you increase your savings rate helps you twofold.

First, it’s increasing the amount of money you are saving and investing. Second, you’re reducing your cost of living, which reduces the amount of money you would need to live on in retirement.

The idea is to figure out what your “enough” costs and save the rest. That isn’t a bare bones “enough”, but an enough that accounts for the things you value the most and cuts down on the stuff you don’t care so much about.

Saving even 20% of your income may seem ridiculously far off right now, but any amount you’re able to save is an investment in your future freedom. The time that you have to save is ultimately more important than the amount, so start sooner rather than later, even if that just means $10 a month at first.

Once you are in a place where you’re earning above your “enough”, you might be surprised how easy it is to significantly increase that percentage when you are aware of and intentional with your spending.

With a little creativity and intentionality, you could cut your years of required work in half. Think about that. Buying time ain’t a bad thing to spend money on if you ask me.

How to calculate your savings rate

To calculate your savings rate, you’ll need to find out how much you’re saving.

Take your post-tax income and subtract your expenses to determine the amount you are saving, or not spending. Then divide that number by your income.

As an equation, it would look like this:

[(Income – Expenses) / Income] x 100 = Savings Rate

Here’s a made up example with someone who has a monthly income of $2,800 and spent $2,100 last month:

[($2,800 – $2,100) / $2,800] x 100

($700 / $2,800) x 100

0.25 x 100 = 25%

Savings Rate = 25%

To get the most accurate number you want to make sure you’ve tracked your expenses for the past month (or whatever period of time you’re using) because just using your bills and estimates will probably give you an inaccurate picture of your actual spending.

Figure out your savings rate for this past month, and see if you can increase it by 3% this next month. Let me know how you do in the comments!

PS — The YNAB link is a referral link, which means that if you sign up for a subscription at the end of your free trial, I’ll get a bonus free month. I wouldn’t recommend YNAB if I weren’t enthusiastic about it, and I think you will be, too! You can sign up for your free trial of You Need a Budget here.

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