Author Topic: calculating savings rate  (Read 14255 times)

Ovid

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calculating savings rate
« on: September 08, 2012, 05:48:24 AM »
Long time lurker, first time poster.  Anyways the chief question I have is regarding how to calculate savings rate.  On the income side of your savings rate, does that include dividends and appreciation of assets not sold (paper gains)?

I realize some would say this is immaterial and each person can calculate it how they want, but as I look at charts and graphs that use savings rate as a point I would like to know if we are all talking about the same thing.

arebelspy

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Re: calculating savings rate
« Reply #1 on: September 08, 2012, 07:42:21 AM »
See this post for a disussion on the topic: www.mrmoneymustache.com/forum/ask-a-mustachian/probably-answered-already-but-i-can't-find-it-calculating-your-savings-rate/

My thoughts:
Quote
There's a million ways to do it.

What you have to ask yourself before you calculate it is why you want to know.  If it's for a specific purpose, calculating it one way over the other may be very important.  Why you want to know (how you will use that number) may determine how you calculate it.

If you just want to know to see if it's going up, then all that matters is calculating it consistently the same way.

I personally do Savings Rate = (Net Income + Gross Tax Deferred Contributions - Expenses) / (Net Income + Gross Tax Deferred Contributions)

I don't count debt principal repayment.  Though I AM saving that money, so I do count those other times (for example, when calculating expenses, especially when trying to calculate/estimate post-FIRE expenses).

Similarly, I don't take off a portion of my tax deferred amount saved to account for future taxes.  (So even though 1k in a Roth is worth more than 1k in a 401k, for saving purposes for simplicity's sake I treat them the same).  But I do take out the taxes on that for other calculations.

So it really depends what you're trying to calculate and why.  How are you going to use that savings rate number, basically.

Hope that helped!

MMM also posted his thoughts in there.

So read that, then let's discuss.  Which way do you like to do it, and why? :)
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ShavinItForLater

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Re: calculating savings rate
« Reply #2 on: September 08, 2012, 08:35:35 AM »
At least during the accumulation (pre-FIRE) phase, I would not normally count investment returns of any kind in calculation of savings rate.  I define savings as the input to the investment process, and investment returns as the output.

I can see it getting gray if you start counting/thinking of your investment returns as passive income (e.g., why would you treat passive different than active), or if you are actually spending so much that you're eating into your investment returns.  It would also be more gray if you own investment real estate as part/all of your income, since that's sort of in between active and passive.

In the context of achieving FIRE I think a clean division makes sense.  Savings rate is how much you're feeding that passive income engine, and once it reaches critical mass then you switch over to living off that passive income.  The YMOYL style graph illustrates this pretty well I think--dividing total income into passive vs. active sources, and when passive exceeds expenses, you are at FIRE.

In the end the bottom line is all the same though--your net worth would rise as the sum of savings and investment returns minus debt repayment.  If you prefer to lump it all together you can. 

A few other reasons to keep them separate:

- I believe most of the FIRE and retirement calculators out on the net separate contributions from returns, so your results would not match theirs.
- Separating them makes it easier to do what-if analysis on things like different expectations of investment return % vs. different savings (contribution) rates.
- Investment returns are often unpredictable, much more than income and expenses for most people (entrepreneurs/self-employed are a different story).  You can *plan* your savings rate better if you aren't counting variable investment returns.  You can't reliably "budget" for investment returns.
- You might lose motivation and actually save less by glomming them together.  In a good investment year, you might say oh I don't need to save as much because my investments covered it.  In a bad year though, you might not be able to cut back enough to make up for the deficit.

c

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Re: calculating savings rate
« Reply #3 on: September 08, 2012, 09:25:15 AM »
I have only been counting the actual money I put into my savings/brokerage account. I don't count 401K contributions from me or my employer, dividends etc or principal on my mortgage.

Going forward I'm going to count the *extra* I pay on my principal, but in a separate column. This is purely for psychological reasons though. I'm going to really ramp up my repayments and don't want to get discouraged by my savings % falling so much. That said, I'm sure after a few months I will stop counting this separately.

There are so many ways people calculate their savings that it's difficult to always know if you are on the right track, though I guess it all boils down to "sock away as much as you can, and them some more".



arebelspy

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Re: calculating savings rate
« Reply #4 on: September 08, 2012, 12:45:45 PM »
Oh yes, regarding the specific question of "do dividends/investment returns count towards savings rate?" my answer is no.  I agree with everything Shavin said.

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Its All About Value !!!

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Re: calculating savings rate
« Reply #5 on: September 09, 2012, 12:55:21 AM »
Can I vent a little?  Not at anyone in particular... just in general.  I (and I imagine others) get frustrated at the inherent ambiguity of financial terms.  In this case (savings rate), I would like to know beyond a shadow of a doubt what that means so I can effectively communicate to other ppl in this forum and elsewhere.  I understand that it can be calculated and used many different ways.... but for a newbie such as myself, it is a barrier to getting up to speed.  I think the active vs passive income is a good example... I was going to include passive income, but now I'm not so I'll have a better chance of being on the same page with others who are more advanced.  Also is a post that arebelspy referenced, it mentions including 401k match contributions, that's probably a good idea.

Maybe part of the trouble is that the term "Savings Rate" lends itself to many interpretations.  Well one way to fix that is come up with a new term for the specific purpose of how saving rate will be used in this forum.  There could even be a couple new terms... just so long as we know exactly what they are.  For example, we could use "Active Income Rate of Savings" or AIRS.  Then of course you could have your "Passive Income Savings Rate" or PISR.  And probably many more.  But eventually, maybe one would become more widely used and popular... as in "Dude, what's your AIRS?  And then he could click on AIRS and see that:

AIRS = Active Income Rate of Savings = Active Income - Expenses / Active Income
Active Income is after tax income and does not include investment returns.  But you should remember to add 401k matching if your employer provides it.
Expenses include anything you've spent money on including the Interest, Tax and Insurance of your mortgage payment if you have one.

I'm sure someone could define it better than me.  But I think many newbies have this same apprehension... and I think some clear definitions and simplicity will allow easier entry into this world of saving and attract more followers!  Basically less ppl saying WTF and more ppl saying this is awesome!

BTW, I hate writing long winded stuff like this... actually writing in general.  So maybe I could of presented this better than what you've just read.  This is a great forum and maybe one day I can be the pro giving advice to some newbie!

arebelspy

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Re: calculating savings rate
« Reply #6 on: September 09, 2012, 08:35:16 AM »
I think the problem with that is even if we want to define it precisely, we won't be able to agree on how.  Further, anyone new coming in won't be familiar with the term, so they'll post their savings rate and it may not match with the definition we're using.

You just have to understand that there's some ambiguity.  It doesn't bother me that someone posts they have a 60% savings rate, and they might actually have a 55% one the way I calculate it, or a 65% rate the way someone else calculates it.  Either way, it's close enough.  Measuring/marking with a microscope and cutting with an axe and all that.

The simplest solution, and likely the only one I can really see being adopted (practically speaking) is for one to define how they calculated it when they post what it is.

Cause I doubt you want to change the way you calculate it based on how I do mine (or how someone else does theirs.. And whose do you choose?)
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.
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Ovid

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Re: calculating savings rate
« Reply #7 on: September 10, 2012, 05:16:56 AM »
Sounds like you have thought about this a lot as well.  After reading this thread I do agree that gains and losses of the stock market would end up muddying the water and not making a clear picture.

I suppose to me the only argument the other way that made me post the question in the first place is, if you are assuming a static draw-down rate (sometimes 4%), you do get closer to retirement through all your gains.

It didn't strike me until reading this thread that by keeping it based solely on your salary, you get the benefit of knowing what you spent as well, which is how the ERE book makes all the nice graphs.

For me, I think it will be simply money sent to accounts (401k, savings, stock market) divided by take home salary (adding in the 401k again).  I will generally do both ways to be with and without the mortgage more of a spinning it forward when the mortgage is paid off.