Will Figuring Out Your Saving Rate Help Increase Wealth?

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Have you ever tried to calculate your personal saving rate? The process can be incredibly simple or staggeringly complex. This post examines the idea behind a personal saving rate, without getting bogged down by the math.

Read any number of finance blogs, and you’ll start to get the impression that many of them are written by math nerds. Left-brained writers who love to crunch numbers and calculate personal saving rates for fun.

I am not one of them.

In fact, I don’t even like the process of making a monthly budget. 

I am trying to save more of my income to catch up my retirement savings, though. Do I need to know my personal saving rate to do this?

You may remember from any basic economics class that your profit, or the money available to save for the future is your current after-tax income minus spending on current needs.

In its simplest form, your personal saving rate is the amount of money remaining each month after you’ve forked over the cash for all your expenses.

As long as you save it! This formula only works if you actually move that money into a saving or investment account. Rather than trying to save what’s left over, try saving a set amount off the top each month. To make saving a priority, automate it by setting an amount to go straight from your paycheck to a designated account.

Saving Rate vs. Savings Rate

While I try to avoid arguments about semantics, it is important to know the difference between the terms saving rate and savings rate. They mean two completely different things. It was during one of the Financial Independence (FI) Chautauqua events we attended that I learned this little nugget of wisdom from personal finance writer J.D. Roth of Get Rich Slowly.

When it comes to building wealth, both your personal saving rate (the amount of income that you save) and your savings rate (the percentage of interest earned on a savings account) matter.

That’s right – your saving rate is the percentage of your personal income that you are saving each year. While your savings rate is the percentage of interest you are earing in a savings account (at your bank, in a regular or high yield savings account, certificate of deposit or CD, etc.)

Getting a higher interest rate on your savings is helpful for growing your nest egg. However, the biggest impact on your ability to build wealth will come from the amount of income you save. That’s why it’s important to know your saving rate when you are tying to build wealth or catch up retirement savings after a late start.

Calculating Your Saving Rate

A very simple way to calculate your saving rate is to figure out how much money you have set aside in savings over the past year. Then, divide that number by the amount of income you made over the same time period.

Your Saving Rate = Your Savings Divided By Your Income 

Your personal saving rate can be calculated by dividing your savings by your income. Here’s a simple math example to illustrate this point:

You save $5,000 of your $50,000 yearly income.

$5,000 divided by $50,000 = 0.10  (10% personal saving rate).

The idea behind calculating your personal saving rate is to determine how much you are saving of your hard-earned cash. If you are trying to catch up retirement savings after a late start, you will need to dramatically increase your saving rate.

Members of the Financial Independence Retire Early (FIRE) community typically save 50% or more of their income. Even those of us who are older and behind in saving for retirement can benefit from FIRE strategies to increase our saving rate. It’s not too late!

Ideally, this knowledge will inspire you to save even more.

It can be complicated to figure out your personal saving rate, however, depending on your unique situation. For example, what do you include when adding up your income?

Obviously, you would include your salary or any wages, tips, and bonus income you receive. If you earn some extra side hustle money you would include that, too.

What about other money that comes in, such as a pension, social security or disability benefits? It becomes even more complex if you own a business or rental property.

Also, do you include any deferred income that is going into an educational saving account or a retirement account?

The money I’m deferring into my 457(b)-retirement plan at work, as well as the money I put into my IRA both make up a huge portion of my savings, so I’d include them when calculating my own saving rate.

Catching up my retirement savings is my biggest financial goal. If you’re reading this blog, I’m guessing it’s one of your financial goals, too.

Calculating your personal saving rate doesn’t really tell you much about how close you are to reaching your financial goals, however.

What You Really Need to Know About Your Personal Saving Rate

There is only one thing you need to know about your personal saving rate:

What Are Your Financial Goals?

That’s right, you don’t have to decide what to include or not include as income.

You don’t have to do any fancy calculations or complicated math.

Instead, identify your goals and come up with a dollar amount that you need to reach those goals. Compare how far away from or how close you are to your goals based on the gap between the specific dollar amount you need and how much you’ve saved.

Not there yet? Increase the amount of money you are saving. Keep reviewing your progress to see what you need to do to close the gap.

How To Increase Your Savings

In my effort to catch up retirement savings, I have tried to live below my means and make saving automatic. With a dollar amount in mind, reaching my financial goal leads me to question all my spending, saving and investing behaviors.

Make it a practice to ask yourself this question:

Does my spending, saving and investing support my goal?

If not, where can I make changes?

More Ideas To Help Increase Your Saving Rate

Increase Your Income

Although I have a full-time job, I have been able to increase my income by developing both passive and non-passive income streams. This has helped me to save even more money for retirement.

Non-passive income:

I have a part-time job in addition to my full-time job. After investing a little time and money into a second degree, I was able to dramatically increase my income.

You don’t have to get another degree to increase your income, though. A second job can be something as simple as delivering pizza or walking dogs.

Another idea is to turn a hobby into a money-making side hustle or a small business.

Passive income:

My favorite kind of income is passive income. It’s the money that comes in even when I’m sleeping! I earn passive income primarily through Vanguard index funds. However, I also make passive income through affiliate accounts promoted on this blog. As noted at the top of this post, if you click on a link and make a purchase, I will receive an affiliate commission at no extra cost to you.

My intention is to share some of the best products I’ve found that have helped me on my path to financial independence, or that help me to maintain a healthy lifestyle. After all, I want to be healthy enough to enjoy retirement once I get there! I’m sure you do, too.

Many of the natural body care products I use are from Miessence, so you will see affiliate links for my favorite Miessence products throughout the blog. Check out the entire line of organic products on the Miessence website or click on the photo below.

Another example of passive income from affiliate marketing is Rakuten (formerly Ebates). Rakuten is a money-saving shopping portal. I go to Rakuten first, then click through to shop at my regular online stores. If I’m going to be shopping anyway, getting cash back helps me to increase my saving rate.

When you use my affiliate link to join Rakuten and spend $25, Rakuten gives you cash back! That’s in addition to the other cash back offers and coupons for stores on their site. If you join through my link, I will also make an affiliate commission, which gets added to my Rakuten rebate check. And you guessed it – I deposit my rebate check right into my savings account!

Maximize Tax Deferred Savings

My goal is to catch up retirement savings, so I contribute the maximum amount allowed to every tax deferred plan that I have access to. The easiest way to make sure this happens is to automate! Withdrawals from my paycheck are made automatically, so I can’t blow the extra money. Automation helps me to increase my saving rate through tax deferred plans.

this Can include:

For me, this includes the 457(b) deferred-compensation retirement plan at my full-time local government job. Similar to a 401(k), the 457(b) is funded with pre-tax money. The taxes are deferred until the money is withdrawn.

Traditional IRA for myself and spousal IRA for my husband, who has a disability and is no longer able to work. If I make too much to contribute to my traditional IRA (due to rules related to having a retirement plan at my job), I may be able to contribute to a Roth IRA instead.

Flexible Spending Account, or FSA. Not a retirement account, but it allows me to use pre-tax dollars to pay for the current year’s medical expenses, which saves money. This tax-free money must be fully spent each year – it’s use it or lose it.

Other savings options that may be available to you:

401(k) or Roth 401(k) retirement plans through your job. Your employer may even offer a match! Funded with pre-tax money, but you pay taxes when the funds are withdrawn.

Traditional or Roth IRA. Traditional is funded with pre-tax dollars, you pay taxes when you take the money out. Roth is funded with after-tax dollars but the growth is not taxed.

Health Savings Account, or HSA. Also called the Stealth IRA by the White Coat Investor. If you have a high-deductible health plan, you can save pre-tax money in an HSA to pay for medical expenses now or in the future. Account grows tax free.

Dependent Care FSA. Parents who must pay for dependent care (most often childcare) in order to work, can set aside pre-tax money for this expense. Although tax-free, the money must be used up each year. Another use it or lose it account.

529 college savings plan. This is a tax advantaged saving plan that makes the most sense to start when your children are young in order to maximize compound interest.

There are additional options for saving for retirement, such as the SEP IRA for self-employed or small business owners.

Live On Less Than You Make

In The Millionaire Next Door, Thomas Stanley and William Danko wrote “Wealth is what you accumulate, not what you spend.” Their research revealed the secrets of first generation millionaires and showed how you and I could become millionaires, too.

Even though I don’t like the budgeting process, I recognize that using a budget will help identify spending areas to cut back on.

The best way to figure out how to live on less than you make is to become aware of how much money is coming in, and how much is going out.  Figure out how to spend less and save what you don’t spend.

The three biggest spending categories for most people include housing, transportation, and food. You may find that some spending categories are easier to cut back on than others. It’s a little easier to cut discretionary spending on items like food and entertainment, but harder to cut fixed expenses, such as rent or a mortgage payment.

The good news is that even fixed expenses can be manipulated to help you save more money. Look for ways to lower your largest expenses to dramatically increase your saving rate. For most people, this is housing.

House Hacking

Can you get a housemate or rent out a room? In his book, The House Hacking Strategy, Craig Curelop describes how you can get started with house hacking even on a low income. Other options for reducing housing costs to consider include moving in with someone else for a few years or moving to an area with a lower cost of living.

Be Proactive 

Identify your financial goals. Is your current income and spending in line to ensure you will reach your goals? If not, how can you increase your income? Is personal debt making it hard to save? Try using the debt snowball strategy to get out of debt.

What else can you do to increase your personal saving rate? It helps to ask this question each month as you review and revise your budget. When you find a way to bring in extra money or to cut an expense, automate that amount to go directly into your savings or investment account.

Summary

Learning the difference between your saving rate and your savings rate can help you to become more financially literate. By calculating your own saving rate, you may be inspired to take steps to increase your income and save more money. Every step you take will help you to reach your financial goals for retirement.

Question:  Have you identified your financial goals? What have you done to increase your personal saving rate to help you reach those goals?

Please share in the comments below!