The savings rate is a simple ratio that expresses how much of one’s income is put away for retirement.
Our family has always been frugal, we always put money away for the future, but never went through the math to see how much it actually is. Honestly, I didn’t even have a ballpark idea of how much we put away monthly as a percentage of our income.
Before we get to our numbers – a few explanations:
What is the savings rate?
The savings rate is fairly simple to calculate:
Income / Savings = Savings Rate
We decided to take a very straight-forward approach. We don’t do any fancy exclusions or tweaking of the numbers.
Simply put, for our calculations:
- Income is what comes in every month.
- Savings is everything that is net worth increasing.
Some people go through the hassle to polish these numbers, but as this is just a performance metric to help us gage how much we save, there is no need to lie to ourselves.
A fellow Swiss bloggers showcased some of the ways to artificially increase your savings rate, check it out here: https://thepoorswiss.com/increase-savings-rate-with-math/
Why is it so important important?
The savings rate is a helpful metric to show how much every month is put towards the future. It also helps with the calculation of the future “financial independence date”.
There is a nifty tool to calculate when that retirement date could be for you: Networthify. By plugging in your annual income, annual savings rate and current portfolio alongside some estimated return figures and the withdrawal rate you get an idea by what date you will be able to retire. I find this helpful, because it gives a good indication if the current strategy matches the FIRE goals.
Of course this is not perfect, but what is really powerful to see is how increasing and decreasing the savings rate can affect the retirement date.
Assuming 100’000 CHF annual income (8’333 CHF monthly), a 50% savings rate (ca. 4’100 CHF per month) and 100’000 CHF in a stock portfolio (with 4% return on investment and a withdrawal rate of 4 % during retirement) I get the following:
By reducing and increasing the savings ratio by 10% the target retirement date changes quite a bit.
|reduction by 10%||increase by 10%|
The main reason for the big jump from 15.7 years to 11.4 years when increasing the savings rate by 10% is that the calculator assumes, that you will continue to live on the same expenses once you retire. So a high savings rate also translates into low expenses in retirement.
The calculator is not perfect. for example it does not take into account inflation, rising health cost with advanced age, increase in salary throughout work career, government pension schemes, one-time pay-out/pay-ins etc.
It does, however, give a very powerful picture to show what the impact of saving and investing can have on the amount of years one has to continue to be in the workforce before retirement is financially feasible.
Calculating the savings rate
As discussed earlier, there really are only two components that go into calculating the savings rate: income and savings.
What counts as income when calculating my savings rate?
The income number for an average person is fairly simple to explain. It is basically anything that gets deposited into your bank account. Most people only have a few sources of income. Here are some examples of income:
- Salary (after social security, pension and other deductions)
- Side-job income
- Interest income
- Rental income
If you add all of those up (and any other sources of cash), you get your income number. Done.
You have your nominator, now let’s move onto the denominator:
What can I count towards my savings when calculating my savings rate?
I am of the opinion, that basically anything that increases the net worth (except for debt repayments) can be added together to calculate the savings rate.
Here are some traditional “buckets” that can be added up to your savings number. All payments into or towards:
- Savings accounts
- Purchase of stocks, bonds, bonds and other (low-risk) investments
- Savings certificates
- Retirement savings accounts (3a pillar)
- Property investments
- Primary home (mortgage payments) – see explanation below
Add these numbers together and you got your denominator.
I am not adding government pension plan deductions and social security payments that get removed from my paycheck before it gets to my bank account.
Does paying off my mortgage count towards the savings rate?
Yes. Now let me be clear: Debt in general is not a good thing, But a mortgage is linked to a appreciating asset – your house. Therefore the more you own of that asset over time, the higher is your pay-out when you end up selling it. On top of that, a paid-off house should be the goal of any aspiring early retiree.
A house without a mortgage on it is basically “free” living.
So here it is. Our savings rate for 2020 so far. We are doing better than I thought.
Have you calculated your families savings rate? I encourage you to check your numbers and let me know in the comments below where you stand.