Author Topic: Savings Rate Calculation  (Read 11299 times)

fmzip

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Savings Rate Calculation
« on: December 09, 2013, 07:12:19 AM »
Is this an acceptable calculation for savings rate?

Gross Income-Payroll Taxes=X
401K Contributions+Employer 401K Contributions+HSA Contributions+Mortgage Principle+YTD Savings=Y

(Note: HSA is being used as as savings vehicle, not used for for expenses)

Y/X= Savings Rate

arebelspy

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Re: Savings Rate Calculation
« Reply #1 on: December 09, 2013, 07:55:01 AM »
It's all up to you, bud.  :)

Everyone has different ways they like to do it.

Some, like you, calculate savings rate based on net income, sure (some do it off of gross income, and thus don't take out taxes).

Some count 401k contributions, others don't (you seem to only count employer 401k contributions in the numerator, but not as part of the denominator?)

Some count mortgage principal pay down, others do not.

There is no one "right way," so decide what flavor is your favorite (I like pralines and cream) and go with it.
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fmzip

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Re: Savings Rate Calculation
« Reply #2 on: December 09, 2013, 08:12:18 AM »

(you seem to only count employer 401k contributions in the numerator, but not as part of the denominator?)


Thanks for the input, could you please explain to me what does this statement means exactly?

grmagne

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Re: Savings Rate Calculation
« Reply #3 on: December 09, 2013, 08:27:04 AM »

(you seem to only count employer 401k contributions in the numerator, but not as part of the denominator?)


Thanks for the input, could you please explain to me what does this statement means exactly?

Your Employer 401k contribution is a type of income, so it should be included in your denominator (especially if you include it in the numerator):

X=Gross Income+Employer 401K Contributions-Payroll Taxes

arebelspy

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Re: Savings Rate Calculation
« Reply #4 on: December 09, 2013, 08:29:38 AM »
Right.  Some people count 401k employer contributions, some don't, but for those that do, it makes sense to count it as both income (in the denominator - i.e. it needs to be added to your gross pay) and as savings (in the numerator).
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Ottawa

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Re: Savings Rate Calculation
« Reply #5 on: December 09, 2013, 08:33:43 AM »
As long as you are consistent for the purposes of your own benchmarks...arebelspy is correct - it doesn't really matter what you use.

If, OTOH, you want to compare to other folks, it helps to compare apples with apples...it would therefore be great to have some kind of 'universal' way of doing the calculation in this case.  Until then, you'll want to make sure you are comparing the same calculation methodology. 

fmzip

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Re: Savings Rate Calculation
« Reply #6 on: December 09, 2013, 08:41:59 AM »
So instead is this more accurate?:

Gross Income+Employer 401K Contributions-Payroll Taxes=X
401K Contributions+HSA Contributions+Mortgage Principle+YTD Savings+Employer 401K Contributions=Y

Y/X=savings rate?

If so, my savings rate for 2013 came out to 46.84%.
« Last Edit: December 09, 2013, 08:53:39 AM by fmzip »

arebelspy

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Re: Savings Rate Calculation
« Reply #7 on: December 09, 2013, 08:50:03 AM »
Sure, that's a fine way to do it.
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 two 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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AlanStache

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Re: Savings Rate Calculation
« Reply #8 on: December 09, 2013, 08:56:21 AM »
This sort of got me when I first reading mmm, I had no clue what was the standard to include or not.  Particularly wrt over paying on the mortgage, or base mortgage payments for that matter as both of these are a significant part of my monthly expenses.

fmzip

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Re: Savings Rate Calculation
« Reply #9 on: December 09, 2013, 08:56:27 AM »
I joined the forum 3 weeks ago. At first glance, 47% looks like we've been doing the right thing.

However, the troubling part though is we have no debt other than a small mortgage and we burned $65K this year through 11 months with just my wife and I. FIRE is not in sight in the near future with that kind of waste!

« Last Edit: December 09, 2013, 09:14:44 AM by fmzip »

grmagne

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Re: Savings Rate Calculation
« Reply #10 on: December 09, 2013, 10:33:02 AM »
As long as you are consistent for the purposes of your own benchmarks...arebelspy is correct - it doesn't really matter what you use.

If, OTOH, you want to compare to other folks, it helps to compare apples with apples...it would therefore be great to have some kind of 'universal' way of doing the calculation in this case.  Until then, you'll want to make sure you are comparing the same calculation methodology.

I'd have no problem with using fmzip's formula as a "universal" methodology, but mabye using a more generic version:

X=Gross Income + All Employer Retirement & Investment Contributions - All Government Income Tax & Deductions
Y=All Employee Retirement & Investment Contributions + All Employer Retirement & Investment Contributions + Mortgage Principal + Other Savings - Savings Withdrawals

Savings rate = Y/X

My only caveat would be that dividend income & reinvestments should be completely ignored from the formula. Otherwise, an older investor would have an unfair advantage because they'd have so much passive income being automatically re-invested.

Depending on the country, the Government Income Tax & Deductions would include things like income taxes, government-sponsored pension plan, unemployment insurance, health care fees or surtaxes, etc.

bo_knows

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Re: Savings Rate Calculation
« Reply #11 on: December 09, 2013, 12:58:32 PM »
Personally, I worry less about calculating some arbitrary "percentage" and more about figuring out exactly the amount of dollars I save in a given year.  Using that number in a more complex online retirement calculator to gauge my progress is my sort of thing, but I'm a bit biased :)

arebelspy

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Re: Savings Rate Calculation
« Reply #12 on: December 09, 2013, 04:40:44 PM »
Personally, I worry less about calculating some arbitrary "percentage" and more about figuring out exactly the amount of dollars I save in a given year.  Using that number in a more complex online retirement calculator to gauge my progress is my sort of thing, but I'm a bit biased :)

(Emphasis mine.)

Agreed.  Figure that number out, and then figure out the amount you spend. 

Then go to the link in bo_knows signature and go wild!

It's in essence the information you need for a savings rate calculation, but a savings rate gives nothing but a metric to try and improve and/or brag about.  It doesn't give much concrete information.
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 two 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.

Heart of Tin

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Re: Savings Rate Calculation
« Reply #13 on: December 09, 2013, 04:59:49 PM »
Iíd like to advocate in favor of a savings ratio rather than a savings rate, because I think itís actually more transparent, easier to calculate, and emphasizes the tremendous importance of spending less. By savings ratio, I mean the ratio of what you save every year to what you spend every year. The savings ratio is a bit easier to understand because all money that comes and stays in goes to the numerator, and all money that goes out goes to the denominator, nothing goes to both. You donít need to fuss with exactly defining income; itís just everything that came and stayed in divided by everything that went out. This has the added benefit of focusing on overall expenses instead of overall income which, as we have seen from a few threads lately, can be disheartening for those of us on the lower end of the income scale. Plus, we tend to define FI by what our net worth or passive income level is in relation to our yearly expenses, so why not give our savings ratio in terms of our yearly expenses as well? The savings ratio frames our conversation in the same terms whether weíre talking about budgeting and cutting expenses or the amount we need to save to reach FI.

Furthermore, lowering your expenses and saving the difference will both increase the numerator and decrease the denominator of the savings ratio which has a huge impact and is really confidence boosting whereas with the savings rate you must increase your income in order to affect the denominator which will usually have a greater impact than only cutting expenses and only affecting the numerator. Additionally, while the yearly increase of your savings rate can sort of peter out once you get to a certain level of spending/income, your savings ratio will continue to increase noticeably even with modest improvements in spending and income.

I know itís a bit less intuitive than the savings rate, but I really like thinking in terms of my savings ratio. For instance, instead of thinking that I had a savings rate of 60% this year, I can frame my savings in real terms as I saved 1.5 times my yearly expenses this year. Both statements mean the same thing, but I find the latter much more satisfying.

grmagne

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Re: Savings Rate Calculation
« Reply #14 on: December 10, 2013, 08:28:16 AM »
It's in essence the information you need for a savings rate calculation, but a savings rate gives nothing but a metric to try and improve and/or brag about.  It doesn't give much concrete information.

I strongly disagree with that last sentence. Since early retirement is a major goal of the majority of MMM readers, and because savings rate correlates strongly with required working years (link below), your savings rate gives you a good estimate of when you'll be retiring. For example, I used fmzip's formula to calculate my savings rate and it's just a hair over 45%. Using MMM's handy little table, I should be able to retire after a 19 year working career. And, remarkably enough, that does fit my expected retirement date within one year. It's not an exact science, but it's a handy little tool.

http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/

arebelspy

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Re: Savings Rate Calculation
« Reply #15 on: December 10, 2013, 08:46:35 AM »
We'll have to agree to disagree then.

In general, it's a fun metric, but not the most useful one.  It's equivalent to using an unsharpened axe for slicing tomatoes.

It's fine for someone a decade from ER.  Anyone less than five years out better be planning a lot more specifically than just "savings rate."
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 two 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.

Ottawa

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Re: Savings Rate Calculation
« Reply #16 on: December 10, 2013, 08:56:53 AM »
It's fine for someone a decade from ER.  Anyone less than five years out better be planning a lot more specifically than just "savings rate."

I agree, it is definitely something that spurs motivation for people just starting into Mustachianism.  You get to see a number change pretty quickly over the first year or two.  That in itself gets the snowball rolling...one not really need concern themselves with other metrics at this stage...

As to the 5 years out...and what things you need to start considering...that's a different topic - and an interesting one.  Planning at this stage becomes a very tailored and personal one.  Thus, the one metric fits all (savings rate) no longer really means alot, as arebelspy suggests.


bo_knows

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Re: Savings Rate Calculation
« Reply #17 on: December 10, 2013, 09:21:51 AM »

In general, it's a fun metric, but not the most useful one.  It's equivalent to using an unsharpened axe for slicing tomatoes.



Absolutely.  This is a common saying (or criticism?) about retirement calculators like www.cfiresim.com and www.firecalc.com... and I will totally agree with it.  There is absolutely no way that you're accurately calculating your retirement date when it's 10+ years away, no matter what metric/calculator you use.  They're all great rough estimates, though.

CDP45

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Re: Savings Rate Calculation
« Reply #18 on: December 10, 2013, 10:48:31 AM »
I guess I don't understand the mortgage principle, because you have to live somewhere so it's difficult to realize those gains. Any links or thoughts on that topic?

arebelspy

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Re: Savings Rate Calculation
« Reply #19 on: December 10, 2013, 11:15:58 AM »
I guess I don't understand the mortgage principle, because you have to live somewhere so it's difficult to realize those gains. Any links or thoughts on that topic?

It's still adding to your saved amount / net worth (and yes, you can tap it if necessary via a number of methods).

For example, let's say someone made 100k after taxes, and spent 20 (including the minimum on their mortgage).

1) They sent that other 80k to index funds.
2) They sent 40k to prepaying their mortgage, 40k to index funds.
3) They sent all 80k to prepaying their mortgage.

Would you argue that person 1 saved 80k, but person 2 saved 40k, and person 3 saved $0?

In any case, at the end they'll all need to accomplish the same goal - passive (investment?) income > expenses.  The person prepaying their mortgage may have a smaller stache, but will have less expenses (no mortgage payment).  The person with the mortgage payment will hopefully have a larger stache and use those investment gains to pay the mortgage from.

In either case it ends up a wash.

That's the thinking on that.
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 two 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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Maltipoomoney

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Re: Savings Rate Calculation
« Reply #20 on: December 10, 2013, 11:58:36 AM »
Thanks for posting this; as I thought, My savings rate has been 28%; I want to increase it to 40% this year 12/2013- 12/2014  by banking a Big Fat Emergency Fund then prepaying the mortgage. Then maybe a little more to 50%+ in 2015 to see what I can live on to FIRE in 2017.  My taxes do take out 30% now total as of last tax return. Yuck.

CDP45

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Re: Savings Rate Calculation
« Reply #21 on: December 10, 2013, 09:36:27 PM »
But I don't think we would consider a paid off mortgage yielding any sort of income unless you rented it out but then you would still need to pay for some sort of housing. I guess during the housing bust it was burned into my mind that your residence was more like a durable consumer good. Is this like an accounting question of whats an asset? I suppose for early retirement purposes I wouldn't consider anything as an asset that doesn't produce income, right? If it doesn't have a yield. Like we don't count lines of credit as an asset. prepaying a mortgage is just reducing debt expense, like paying off a credit card.

So no, I don't think a primary residence should be included in net worth. Maybe housing is thought of differently because it historically has gained in value.

In most cases it really helps FIRE to have a home paid off because it reduces monthly expenses...so maybe Personal Property that reduces expenses can be thought as more advantageous than a vehicle or couches. But there is some point at which this type of property just becomes fluff , like some sort of average rent concept and if you pay too much more than that it not really a necessity.

Example:
Average) 4500/mo in expenses incl $1500 mortgage on $300,000 house. FI/RE occurs, now $3000/mo expenses with paid off house.
Extreme) 6000/mo in expenses incl $3000 mortgage on $500,000 house, FI/RE occurs, now $3000/mo expenses with paid off house.

The extreme buyer is short $200,000 in income producing assets given equivalent take home pay/investments etc right? But would we say the extreme buyer had the same savings rate given less of a 'Stache? 
 
Given A,B,C scenarios, if net investment returns were greater than net mortgage expense, they would not be equal scenarios and A would be best off. Given the low mortgage rates I bet most people would see their net worth rise faster under scenario A. That's the issue with a primary residence, it's hard to realize the gains and almost any other investment is better. 

arebelspy

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Re: Savings Rate Calculation
« Reply #22 on: December 10, 2013, 09:54:32 PM »
Feel free to start another thread on this CPD if you'd like to discuss it more, let's not sidetrack this one any more.
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 two 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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erikdhoward

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Re: Savings Rate Calculation
« Reply #23 on: December 14, 2013, 11:59:07 PM »
CDP, I think comparing allocation of funds vs. size of mortgage (i.e., $300k to $500k) is slightly like comparing apples & oranges, especially if part of the assumption is equal take-home. However, with regards to allocation, if I have a mortgage and I want my passive income to cover my living expenses, I can either pay those expenses now or wait until my passive income surpasses my needs. Given a certain yearly allocation, it takes longer to grow a passive fund than it does to pay off a mortgage (e.g., if extra $1k monthly, it would take 13yrs to pay off $300k mortgage vs. 19yrs to grow a fund of passive income equal to the monthly mortgage payment).

fmzip

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Re: Savings Rate Calculation
« Reply #24 on: August 25, 2014, 08:43:02 AM »
So instead is this more accurate?:

Gross Income+Employer 401K Contributions-Payroll Taxes=X
401K Contributions+HSA Contributions+Mortgage Principle+YTD Savings+Employer 401K Contributions=Y

Y/X=savings rate?

If so, my savings rate for 2013 came out to 46.84%.

I was taking a quick look at my savings rate so far this year. I sold my weekend play car and invested the proceeds. Do I add that to my "savings" for the year?

Without the sale factored in it looks like this:

Wife and I:
Gross Income $82,100
401K Contribution $22647
Taxes $25179

$82,100+$22647-$25179= $79568(X)

401K Contribution $22647
HSA Contribution $3644
401K Employer Contribution $14537
Savings $19,100
Mortgage Principle $4000
Total $63828 (Y)

$63828/$79568=80.21% YTD Savings Rate

If I add in the car sale of $18000, X becomes $97568 and Y becomes $81828

$81828/$97568=83.86% YTD Savings Rate

Am I really saving this much??? My math must be wrong




« Last Edit: August 25, 2014, 09:06:47 AM by fmzip »

grmagne

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Re: Savings Rate Calculation
« Reply #25 on: August 28, 2014, 09:53:45 AM »
So instead is this more accurate?:

Gross Income+Employer 401K Contributions-Payroll Taxes=X
401K Contributions+HSA Contributions+Mortgage Principle+YTD Savings+Employer 401K Contributions=Y

Y/X=savings rate?

If so, my savings rate for 2013 came out to 46.84%.

I was taking a quick look at my savings rate so far this year. I sold my weekend play car and invested the proceeds. Do I add that to my "savings" for the year?

Without the sale factored in it looks like this:

Wife and I:
Gross Income $82,100
401K Contribution $22647
Taxes $25179

$82,100+$22647-$25179= $79568(X)

401K Contribution $22647
HSA Contribution $3644
401K Employer Contribution $14537
Savings $19,100
Mortgage Principle $4000
Total $63828 (Y)

$63828/$79568=80.21% YTD Savings Rate

If I add in the car sale of $18000, X becomes $97568 and Y becomes $81828

$81828/$97568=83.86% YTD Savings Rate

Am I really saving this much??? My math must be wrong

Your Employer's 401k contributions ($14537) definitely count towards X because they're part of your income. Putting it in the numerator without including it in the denominator would inflate your savings rate.

Did you double-count your own 401k contributions ($22647)? Normally that's already included in gross income so you don't need to add it a 2nd time.

I think it's OK to include your car sale into the equation for this year. But you should compare that against other years to see what you save in a typical year. A one-time boost in income & savings isn't a good indicator of your normal savings habits.