Tracking your savings rate is a major corner stone metric when it comes to the financial independence journey.
Savings rate is simply a percentage calculated by taking the amount you save each month and dividing it by your income.
Given how complex defining income can be, is there perhaps a simpler, more accurate and ultimately more useful way to represent how much we're squirrelling away for FI?
Before we dig into the weeds, it's probably worth mentioning that getting into the minutiae of savings rates and other metrics isn't a prerequisite to achieving financial independence. For a lot of people, simply keeping things at a high level of "I save half my income" is good enough. That's perfectly fine.
However there are lots of us in the financial independence community who love getting into specifics and optimizing everything from our taxes and investments through to how we track everything. For the nerds among us who love this stuff,...lets dig in.
Generally savings rate is represented as a percentage and is calculated as follows:
For Joe Bloggs who earns $60k per year and saves $2k per month, he would calculate his savings rate as:
Great, simple enough.
Calculating savings rate is quick and easy, but the confusing part comes when you need define income:
Speaking from personal experience, Thrifty-Wife's compensation package from her company is fairly complex involving company vehicles, fuel benefits and percentage based retirement contributions. I on the other hand have side hustles in addition to my regular job for which tax is only known at the end of the year.
The FI community is a great and generally very open group of people which means you'll often hear people mentioning what their savings rate is. However without knowing how they've defined "income", the percentages mentioned mean absolutely nothing.
The three puzzle pieces of FI which impact each other are: Income, Savings and Expenses. Changing one of those three affects the other two and as a result your financial independence timeline is also affected.
We've already discovered that defining "income" is often easier said than done and is far from uniform. What if we instead use two parts of the FI trinity that are easy to quantify, namely: Expenses and Saving.
Going back to Joe Bloggs who saves $2k per month and spends $3k per month. Using the following calculation we can calculate his saving-to-expense rate (or saving multiple) as:
Using Joe's numbers:
This means that Joe saves 66.7% in relation to how much he spends each month. It's intuitive, simple to calculate and involves two easy to define numbers (ie: expenses and saving).
Lets compare Joe's numbers to Super Saver Sally who saves $3 100 each month and spends $1 900:
Awesome, Sally saves 163.16% in relation to how much she spends each month. Go Sally!
Once again, saving-to-expense rate is a quick and easy calculation but has a few benefits that savings rate doesn't have.
Are there actually any benefits taking income out of the equation? Well yes there are:
The goal of FI is to have saved enough to cover your living expenses. By using the saving-to-expense rate, you're comparing the two components which ultimately determine whether or not you've reached FI.
Ultimately getting into the minutiae like this isn't absolutely necessary as long as you're spending intentionally, lowering your unnecessary expenses and investing as much as possible.
However for those of us who enjoy analyzing our FI journey, the saving-to-expense rate is arguably a superior metric to the traditional savings rate while being easier to quantify precisely.
Article by Brendon @ Money FI