Author Topic: Probably Answered Already But I Can't Find It: Calculating Your Savings Rate  (Read 9574 times)

kkbmustang

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I'm sure this has been answered already, but I can't find it. How do you calculate your savings rate? Do you include your mortgage payment (principal, not interest) as part of your savings number (numerator)? Obviously, 401(k), IRA and other savings accounts get included. Do you do it on a gross or net of taxes basis? I know this is such a basic question, but I'm just trying to benchmark our starting point as a way to measure progress. Thanks.

JohnGalt

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I think this will come down to personal preference....

For me:  I use my after tax income but add back in 401k contributions and employer match to get the denominator.  Debt principal repayment + After tax savings + 401k contributions (including employer match) then make up the numerator. 

I don't like including taxes because it's something I have no control over right now, but will go way down in retirement.

kkbmustang

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Thanks. I'll figure out my percentage using that formula. So long as I stay consistent I can measure how we're doing.

arebelspy

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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!
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MMM

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I always counted debt repayment (including the principal portion of mortgage payments), since it is increasing your net worth. And paying off a house is purchasing an asset that actually pays you forever, just like a stock, in the form of free rent.

A retired person who owns a house with no mortgage is in a very different position than someone who is forced to continue renting an apartment or house of equal size.

So if you have $100000 in gross pay, but then pay $10k in taxes, $10k to 401k, 3k to mortgage principal and 10k to interest, and 20k to everything else, I'd argue that your annual savings are:

100k - 10k taxes - 10k mortgage interest - 20k everything else = 60k.

And your savings rate is 60k divided by your take-home pay (90k) = 66%.

For frugal early retirement purposes with US tax rates, this allows you to plan your retirement budget well.
- Taxes will be close to zero if you arrange income to just cover your expenses.
- If you DO earn much more in retirement and pay taxes on it, you don't care, because you'll end up saving it, so you'll still end up being in the "accumulation" phase, and the spreadsheet will keep getting better.


kkbmustang

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Thanks!

arebelspy

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I always counted debt repayment (including the principal portion of mortgage payments), since it is increasing your net worth. And paying off a house is purchasing an asset that actually pays you forever, just like a stock, in the form of free rent.

A retired person who owns a house with no mortgage is in a very different position than someone who is forced to continue renting an apartment or house of equal size.

I agree with all of that, however it goes back to what I said above about why you want to calculate it.

If you FIRE after 10 years, you may still have 20+ years of mortgage payments (including principal) that you haven't calculated in, as you've only been counting the interest as needing to be paid.   That is, your ER budget will be higher if you count your whole mortgage payment, and not just the interest, so even though the principal may be adding to your net worth, you'd still better have a budget that includes that payment (and thus includes at least a small part of savings in it, via that principal pay down).

If you're just wondering how much your net worth is going up, absolutely count that principal.  So, IMO, how you should calculate a number depends on why you are calculating that number.
« Last Edit: August 24, 2012, 07:06:00 PM by arebelspy »
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
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MMM

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Ahh, right.

I had implicitly assumed that most homeowners would want a paid-off house to coincide with the start of their early retirement.. but with today's interest rates, that might not necessarily be so.

For conservative people, I still recommend it though. It is a really nice feeling, and a sound asset allocation strategy as well!

kkbmustang

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I'm assuming our house will be paid off by the time we "retire." Although, my current plan is to semi-retire before I retire. Retire from the psycho 70 hour a week job and work a part-time 20-25 hour a week semi-retired job before I actually pull the trigger and retire for realz. I'm waiting to hear back from my 70 hour a week employer about a part-time option as I'm currently on LTD (with income replacement, thank God) and won't physically be able to even do a 70 hour week even if I wanted to for probably a year. If they say no (I'm coming up on the end of FMLA protection period), then I'll freelance from home and be self-employed. Either way I can make a really good income being semi-retired.

Until I got hurt, with employee and employer contributions to our 401(k)s, we were able to sock away about $40k a year for the last 3 years (in addition to what we had saved in our plans before those 3 years), but we still have student loans. So, we're dialing back the 401(k)s to pay down the SLs.

I had never calculated our savings rate, just kept maxing out the 401(k)s and not really worrying about the rest - just assumed that if we were contributing the max we'd be fine. But, I've been educated in the MMM ways. So, we're working on increasing our savings percentage. We've started tracking our expenses in Mint. August was our baseline month.

I've got lots of things to research like reducing our insurance expenses and utilities, which seem very high compared to MMM. Grocery budget got slashed for September. Eating out got slashed. Entertainment, buying books and movies, etc. have been slashed. Childcare got slashed (no more after school care since I'm not currently able to work full time and my husband's job has some flexibility). The child care alone saved $620/mo. But, the COBRA is new, so healthcare went way up. We've already maxed out our out-of-pocket deductibles for the year and everything else is covered at 100%, so to jump over to hubby's insurance (which isn't very good) we'd be starting all over and it doesn't make financial sense to do so. But, we'll move when open enrollment begins.

Anyway, I'm learning tons in the forums, so thanks a bunch.

kolorado

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I'm glad MMM threw his hat in on this one because I took it upon myself this morning to try to figure out our expected savings rate this year. I must have figured it out 10 different ways with rates of 28-41%. Everyone seems to have a different formula.
When I figured it in the past and came to a 15-40% savings rate I figured it like this:
Gross income(income as earned plus employer's 401K match)-taxes+investment income+tax return/our 401K contribution+their 401K contribution +net savings. I never included mortgage principle payments as savings because until the last couple of years, payments made were at a higher interest rate than I was getting with our savings/investments, which made housing a depreciating asset, not an appreciating investment, at least that's how I figured.
But doing it MMM's way exactly(and of course with interest paid/earned now reversed!), we expect to have a savings rate of 37% this year. We're a one income family and hubby makes just under $20hr. I think our rate is pretty awesome!
I do wonder why investment income isn't counted as income. If you earn $50K year at your job and another $20K in investment income and save $20K from your regular pay as well as all $20K of your investment income, shouldn't your savings rate be 57%? Without counting investment income, your saving rate would only be 40% even though your savings grew. Just curious why this wouldn't be counted in. Figuring investment income we'd get our savings rate up to 49%. ;)
Although I agree it mostly matters when comparing your numbers year to year to increase your savings rate, it also matters when people say how much they are saving and how many years at that rate it will take to reach ER/FI. I mean, when my husband first signed up for 401K at work in his early 20's the Human Resource department promised that if he'd put in just 3.5% with a 50% company match(and at a 12% return no lie!) he'd be a multi-millionaire at retirement. Luckily we know how to do basic math didn't follow their "advice". Unfortunately most people do and that why accurate percentages and a standard formula for calculating should matter.

arebelspy

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I do wonder why investment income isn't counted as income. If you earn $50K year at your job and another $20K in investment income and save $20K from your regular pay as well as all $20K of your investment income, shouldn't your savings rate be 57%? Without counting investment income, your saving rate would only be 40% even though your savings grew. Just curious why this wouldn't be counted in.

It all goes back to why are you calculating it.  In some circumstances you would count it.

In general it's not counted in the time to FI calculations because you put in the amount of your current stache, and how much you're saving outside that, and the calculations have a presumed return on your stache, so it is counted, and if you counted it in how much you saved that year, it'd be double counting.  If you put a stache of 0, and counted it in that year's savings (so it wouldn't double count), it'd be a wash.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, 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.