A better alternative to tracking your savings rate

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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?

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Why bother tracking anything at all?

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.

Calculating your savings rate

Generally savings rate is represented as a percentage and is calculated as follows:

(Total amount saved per month / total income per month) * 100 = savings rate

For Joe Bloggs who earns $60k per year and saves $2k per month, he would calculate his savings rate as:

  1. 60 000 / 12 = 5 000 income per month
  2. (2 000 / 5 000) * 100 = 40%

Great, simple enough.

How do you define income?

Calculating savings rate is quick and easy, but the confusing part comes when you need define income:

  • Do you use pre-tax or post-tax income?
  • How do you take into account company retirement contributions?
  • What if you receive benefits from your company that indirectly affect your income?
  • What if you have side hustles generating income for which you pay tax on an annual basis and therefore have no idea what it is on any given month?

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 financial independence trinity

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:

(monthly saving / monthly expenses) * 100 = saving-to-expense rate

Using Joe's numbers:

  • (2 000 / 3 000) * 100 = 66.67%

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:

  • (3 100 / 1 900) * 100 = 163.16%

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.

The benefits of calculating your saving-to-expense rate

Are there actually any benefits taking income out of the equation? Well yes there are:

  1. The first benefit of favoring saving-to-expense rate over the traditional savings rate is that income is often hard to quantify. On the other hand, it's easy (and exact) to calculate how much we save and how much we spend each month. In my family's case, due to the fact that our income is fairly hard to define due to the previously mentioned factors, it often looks like our expenses and saving comes to more than our income, but that's not true.
  2. The second benefit of the saving-to-expense rate is that it directly compares the two most important components of achieving FI, namely savings and expenses. Achieving FI is all about how much you save in relation to how much you need to live on (ie: your expenses).

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.

As long as you're making progress to financial independence

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.

Have you experienced any shortcomings with the traditional savings rate calculation?

Let me know in the comments.

Article by Thrifty-B

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