Author Topic: How do you calculate your savings rate?  (Read 6254 times)

shedinator

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How do you calculate your savings rate?
« on: March 21, 2012, 09:50:09 PM »
I've been having a discussion with a friend, and he and I disagree over how to calculate savings rate.
We have four main areas of contention:
-Gross vs. Net
-401(k) Matching
-Un-earned income (gifts, revenue from garage sales, etc.)
-Tax Credits (returns which exceed total amount paid into the system).
By my reckoning, all of these things are income. So if a family of 3 earns 15,000, gets a 100% match on 6% 401(k) contributions, receives maximum EIC and CTC, and cash gifts of $50, their total income for the year is 15,000 + 900 + 4050 + 50= 20,000. If they use their tax return to fund an IRA, that combined with the 401(k) contribution and matching totals 5850, and their savings rate is 29.25%.
His opinion is that only your take home pay and pre-tax deductions should count. So that same family has 900 pre-tax income, and ~11542.50 take home pay, for a total of 12442.50. Their total retirement funding is still 5850, but using his numbers, it's a 47% savings rate.

Looking at the handy little chart MMM and ERE use, this difference in calculation amounts to around a 20 year discrepancy in retirement projection.

So... how do you do the math on this one?
« Last Edit: March 21, 2012, 09:57:33 PM by shedinator »

Mirwen

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Re: How do you calculate your savings rate?
« Reply #1 on: March 21, 2012, 10:05:04 PM »
The way I understand it is this.  That ratio depends on two things, spending and saving.  Anything that goes into either of those categories should be counted as income, however things that don't, like taxes, should not be.

arebelspy

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Re: How do you calculate your savings rate?
« Reply #2 on: March 22, 2012, 09:37:50 AM »
Ultimately, it doesn't matter.

Different people are going to look at it different ways, and get different results.  As long as their projected results work based on the inputs they're using, it's fine.

Savings rate is mostly an academic number anyways.

But the difference in people's philosophies comes down to a difference in questions they're asking.  One may wonder "How much money, out of all the money I get, am I saving?"  In this case, they'd want to use gross, count retirement contributions towards saving, subtract taxes, yadda yadda.  Others may want to know how much of their take home they're not spending.  So they'd want to look at net, ignore retirement, etc.  It comes down to a different question being asked.

In any case, here's what I do to calculate "savings rate."  It's likely very different from what many do.

Only count net income.  Ignore taxes and also ignore contributions to retirement accounts.  Ignore income from other investments.  Ignore income from other sources (gifts, investments, etc.)  Subtract expenses from net income.  Divide that number by net income to get "savings rate."

That basically gives me the percentage of my net W2 income that I'm saving.  That's the number I'm interested in.  I don't care how much of my gross I'm saving, or how much I'm saving of birthday money, or how much my taxes are, etc.

The basic question I'm answering is: out of the money I take home from my job, what percent can I keep?  Thus it makes sense why my contributions to by 457b aren't counted in my "savings rate" (I don't take that home).  Or why my taxes aren't counted, or why I don't count my income from my rentals.  I only see how much of my W2 take-home income I can not spend, and invest.

In the end, there is no one definition, because different methods work for different people, and that's fine.  :)
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sol

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Re: How do you calculate your savings rate?
« Reply #3 on: March 22, 2012, 09:49:13 AM »
In the end, there is no one definition, because different methods work for different people, and that's fine.  :)

That's fine, except that the graph he quoted relates savings rate to working years.  For that graph to be accurate, you would need to calculate the savings rate the same as the author of the graph did.  And how was that?

arebelspy

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Re: How do you calculate your savings rate?
« Reply #4 on: March 22, 2012, 10:14:37 AM »
In the end, there is no one definition, because different methods work for different people, and that's fine.  :)

That's fine, except that the graph he quoted relates savings rate to working years.  For that graph to be accurate, you would need to calculate the savings rate the same as the author of the graph did.  And how was that?

Good point.

That's why I said it's mostly academic.  The real important calculations are done based on expenses and portfolio and returns and withdrawal rates.

But if you absolutely like that idea as a motivator, instead of relying on a pre-made chart, calculate using your own numbers.  I believe I had a comment (within the first few comments on that post) linking to an excel spreadsheet where you can calculate your own years to retirement based on your own savings rate.  Then you don't need to know what the assumptions used to generate that chart are.
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shedinator

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Re: How do you calculate your savings rate?
« Reply #5 on: March 22, 2012, 10:34:28 AM »
In the end, there is no one definition, because different methods work for different people, and that's fine.  :)

That's fine, except that the graph he quoted relates savings rate to working years.  For that graph to be accurate, you would need to calculate the savings rate the same as the author of the graph did.  And how was that?

Right.

The example family is living on 11542.50 annually,  and saving a total of 5850. Using the standard MMM assumptions for rate of growth (7% inflation-adjusted, an annual investment yields 14x itself over 10 years), that 5850/year will grow at a rate that looks like this:
10 years- 81,900
20 years- 245,700 (Balance @ 10 years doubled, and added another 81900)
30 years- 573,300
40 years- 1,228,500
50 years- 2,538,900

The family needs 11542.50 annually at their current spending rate. At a 4-5% withdrawal rate, they'll have more than that at 20 years. At a 2-3% withdrawal rate, they'll be there somewhere between 20 and 30 years. By 40 years they can withdraw less than 1%, and at 50 years they can withdraw less than 1% and give half of it away. I don't know what the assumed withdrawal rate is, but I'm guessing it's between 3 and 4%. I'd say it's safe to assume that with the average rate of return, this family could retire after no more than 27 years of investing the 401(k) and tax return moneys (although the 401(k) might not be accessible... that's another story). Based on the chart, that looks like right around a 30% savings rate, which seems to line up well with my earlier calculations.

So it seems like the assumptions made by the chart are that you are using ALL money saved, regardless of source or savings location, as your numerator, and ALL money brought in, earned or unearned,saved or spent, as your denominator.

MrSaturday

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Re: How do you calculate your savings rate?
« Reply #6 on: March 22, 2012, 11:52:06 AM »
In the end, there is no one definition, because different methods work for different people, and that's fine.  :)

That's fine, except that the graph he quoted relates savings rate to working years.  For that graph to be accurate, you would need to calculate the savings rate the same as the author of the graph did.  And how was that?

The chart in the linked blog represents savings rate as the amount saved in taxable accounts as a percentage of net income.  It's from the ERE book so in that context retirement accounts aren't considered. 

It also ignores tax and cost of living considerations in the interest of simplicity.

So for those reasons it's just a simple illustration to demonstrate the effects of increasing your savings rate.  It should only be used as a base toward understand what an individual needs to work toward.  For me, I'm old enough that my retirement accounts are a significant factor in determining my retirement age and plan, so the chart doesn't apply as well to me as it would to a 25 year old looking to retire as quickly as possible.

arebelspy

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Re: How do you calculate your savings rate?
« Reply #7 on: March 22, 2012, 02:12:14 PM »
So for those reasons it's just a simple illustration to demonstrate the effects of increasing your savings rate.

Exactly.  You can get more fine-tuned by using the excel spreadsheet I mentioned earlier.

Sounds like that chart is how I do it (based on net, ignore taxes, only include taxable savings, not retirement savings), but still would rather run my own numbers.

That being said, even running your own with that years to retirement idea is too simplistic, as your expenses may change in retirement, you've likely already been working a certain number of years, your income may rise before retirement (your expenses may as well, and at different rates), etc.

It really is mostly academic.  Don't take that chart too seriously, any more than you take a chart that shows compound interest making you a millionaire seriously.  It does work, but it's more to teach a lesson than actually practical.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.