Over the last 2 years, I have
enlightened annoyed my family and friends by sharing my personal finance knowledge with them. Boy, have I annoyed them. Being obsessed with my own personal finance, I couldn’t understand why everyone else wasn’t dying to talk about it. Unfortunately, most people save only a small percentage of their salary and that is the extent of what they want to think about. It got me thinking, if most people I know are putting away a portion of their earnings every month, why I am the only one talking about FIRE? How come there aren’t lots of other people out there preaching the wisdom in saving early and often, and achieving financial freedom?
I am single, having moved out of home many years ago now. I have been in charge of my own personal finances since I started earning a regular income. The first few years, I made the same mistakes that most people make in their 20’s, but when I discovered the potential of FI, I started monitoring my finances militantly. I never spent a penny without factoring it into my budget. I thought this was the best way to save. Focus on what you spend, and you can always figure a way to save a little more here and there. Yes, this did work, but how much was it helping?
Well my enlightenment came when I read about the savings rate. After 2 years of saving, I realised that I was counting every euro spent, down to the coppers, but I was still completely in the dark about what that amount actually meant long term. You can track your savings several ways, each person might prefer a different method, but calculating and tracking your savings rate is the top dog.
Sounds pretty simple, right? It is a very straightforward concept. Seeing as we are all pursuing Financial Independence, I am going to assume that you are saving your money by investing it rather than sitting idle in a savings account. The key part of this concept is that we are focusing on the money that you are NOT spending.
Since learning about this, I primarily track my savings rate, while still keeping an eye on the monetary amounts as a secondary metric to follow.
Prior to the Savings Rate Era
Once upon a time, I read an article stating that we should all aim to save about 10% of our salary. I cannot remember the source but I took it to be gospel and that was my goal. At the end of each month, I put away whatever money was left over in my account and if it was 10% of my monthly salary, then all was well in the world and I was happy. Anything less than 10%, I felt guilty and I tried not to spend as much the next month, so on and so forth.
This worked for me and I really did think I was doing the right thing to set me up in later life.
Of course, when I discovered Financial Independence, I wanted to save as much as possible. I couldn’t just hope that I don’t spend too much, I began actively tracking everything I spent, creating a budget for each category of spending and striving to stick to that.
Again, this worked, I was saving more money at the end of the month because I was more aware of what I was spending, and on what, so I knew where I could stem the outflow of cash.
While it did work, it was very time consuming. If you didn’t track your spending daily, you would have to spend hours going over your transactions at the end of the week and month. It got old, but I powered through for the sake of my FI journey.
This was the first game changer that I encountered on my FI journey. I don’t even remember where I first heard the concept, but the difference it made was genuinely huge.
Decide how much to save. Put it into savings immediately when you get paid. Don’t worry about the rest.
As soon as I heard this, I implemented it the next paycheck. I was saving exactly how much I wanted each month, with no extra effort and far less stress and energy.
Save first, spend later
You can follow this way of saving by paying yourself first. As soon as the paycheck arrive, siphon off your decide amount. Whatever is left, is what you live on for the month.
Now, this requires you knowing what you necessary expenses are each month such as rent/mortgage, transport, etc. You don’t want to leave yourself short each month by putting away all your salary. But by changing the order of how you approach your finances, you can seriously reduce the level of discretionary spending each month. By limiting the amount of left over disposable income after savings, it will force you to choose between spending on thing A vs thing B, rather than being tempted to do both if you still had the cash on hand.
You no longer have to constantly fight with yourself and try exercise self control. The anti-budget changes the way you approach money in general.
Introduction of the Savings Rate
Everyone who has read up on FIRE has come across a well known MMM blogger who really simplified things for many people and helped them see the errors in the way they were saving.
One of his most popular posts, The Shockingly Simple Math behind Early Retirement, did exactly what it said on the tin, shocked you at how simple it seemed.
Essentially, the post can be summed up with the following table:
|Savings Rate (%)||Years to Retirement|
|90||Less than 3|
|95||Less than 2|
The table speaks for itself but let’s focus in on a few things:
10% Savings Rate = 51 years to retirement
As mentioned earlier, I started out aiming for 10% and was happy to hit that mark. I started my career at 24, so retire at 77? F**k that! Straight away, this article opened my eyes wide to the importance of the savings rate.
All of a sudden, all those people I mentioned at the start, who saved every month but were still slogging away until near 70, make sense. They were hitting the average savings rate for society of 10 – 15%, but that wasn’t getting you to FI any faster.
The more you save, the earlier you retire
Increasing your savings rate doesn’t reduce your working life linearly. In fact, you can make the biggest difference in the lower savings rates. By increasing your savings rate from 10% to 20%, knocks 14 years off your working life. Increase it to 30% and yet another 9 years melts away.
That seems like a pretty good deal to me. You can literally buy your freedom. The choice is yours of how much money you want to trade for extra time.
The Importance of Savings Rates
I have been saying from the beginning, the savings rate in the best tool to measure savings for financial independence. Why?
It does not care about your income
One of the biggest misconceptions is that you need a certain earning power in order to retire early. Based on savings rate, it is not true. Yes, having a higher salary can help, but the savings rate doesn’t take into account the level of your income, it only focuses on how much of it you save.
Let’s look at 2 scenarios:
- Person A earns $100,000/year, saves $20,000, so a savings rate of 20%
- Person B earns $40,000/year, saves $20,000, so a savings rate o 50%
Both A and B save the exact same monetary amount each year, but person A will retire in 37 years compared to person B who can retire after 17 years.
Person B can retire 20 years earlier!!
Let’s break this down a little more. Person A, while saving $20,000 each year, is still spending $80,000 in that year. On the other hand, Person B is only spending $20,000 in the same time.
Person A will require a much larger asset base to cover living expenses of $80,000 each year, therefore will take an extra 20 years to build up that asset base.
What is person A decides to mimic person B, and lives on $20,000/year. Now they are saving $80,000, bringing their savings rate to 80% and now they can retire in 5.5 years.
You calculate your retirement year
We know from earlier that Savings Rate = % of your income
This takes into account your income, savings and expenses. We saw from Person A, if you want to retire earlier, you increase your savings rate. This can be done, like Person A, and increase the amount of savings by reducing expenses. Or you can increase savings by increasing your income without changing expenses. Even a combination of both for even more drastic reduction in your working life.
Calculating the Savings Rate
This calculation is extra simple in Ireland, where I am based for several reasons. Unlike countries such as the US, Irish employers will deduct your taxes directly from your salary for you and you don’t have to think about them again.
Step 1: Establish your take home pay (Income)
As my taxes are already deducted, as well as any pension contributions, what goes into my account, is 100% mine, therefore, I just use this as the take home pay.
Sometimes, tax can be calculated incorrectly by employers for a variety of reason, so you can claim back from the revenue at the end of the year, for any over payments. I view these as unexpected windfalls, that are added into the savings, but they are still excluded from calculations as they are not guaranteed.
*I recognise that will skew the results slightly, but it means that I am under calculating my savings, therefore over estimating the length of time to retirement. Better this way around than the other.
Step 2: Establish your total savings
This is a slightly contest area with some people. I include any money that I use in savings accounts and investment accounts.
Again in Ireland, all pension contributions are deducted at source. But there is a private or state scheme. The state scheme cannot be accessed until after retirement age, no matter what. Therefore, I do not even think about these contributions. That is extra money down the line, but it is no use in my early retirement. Other private pensions with employer matching could be counted as some of these can be accessed sooner, but as I have only started in private company, I will only be able to open a private pension next year, due to company policy. So until then, just savings and investments are included.
*As before, this probably under estimates the savings rate but I prefer to focus on what I control, and not including any funds I cannot control access to.
Step 3: Do the calculation
Divide your total savings by your take home income, multiply by 100 (to get a percentage) and voila! You have your savings rate.
Now, you can do this monthly or yearly and keep track however you like. Personally, I like to keep an eye on it monthly, purely because it helps keep my spending under control, and ensures that I keep myself on track.
How to set a Savings Rate
Some people can pick a random savings percentage and aim for that. If you are one of those, then go for it! More power to you.
What if you have expenses each month and want to pick a rate you can handle?
First thing I did when trying to decide my initial savings rate was sit down and figure out how long I was realistically happy to wait to retire. I decided that I would aim for 15 years from now, so before I hit 45. That means I need to be looking at a 50-55% savings rate as per the table above.
Next, I tracked all my spending for a month, both necessary and unnecessary expenses. Grouped all of these into categories, so as to make it easier to figure the best places to start reducing expenses.
I was already achieving a savings rate of 20ish% so that was a good start point but I also had a lot of unnecessary expenses, so I thought I would try push this up to 30% and see how it would go. Now you can choose a more conservative approach with 25%, and maybe increase it by 1% every month until you reach your target, but the key here is that each month, you slowly increase towards your desired savings rate.
The final thing I must mention, always have this as an open discussion with your significant other. I am single so I can make a unilateral decision about this now, but it is impossible to try save when one half of a couple wants to save and the other is spending away because they aren’t on the same page.
How to increase your Savings Rates
Currently, my savings rate is 0%
Yep, you read that correctly. Zero.
Increase your Income
My savings are a victim of circumstance. In order to change careers, I had to take a significant salary cut. So right now, I am living on €23,000/year. Most of the expenses are made up of housing, transportation and groceries.
But, my salary will increase with every promotion, and fast will increase to a significant level. My spending will stay the same though. Lifestyle inflation is a very common phenomenon (as you earn more, you spend more), but I will try resist the temptation to spend more when the salary increases. Let’s imagine my salary increases to €45,000 in few years, but my spending says the same. After tax, the take home will be €34,000. Potentially, I could be saving €11,000, a savings rate of 32%
32% ain’t bad. Going from 0 to 32 in a few years is a great jump, purely out of promotions. Any extra promotions after that will be increasing the savings even further. Increasing your income is a sure fire way to increase your savings rate.
I can already increase my savings rate by reducing my food expense and transport expense.
I spend too much on takeaways, and I have a car which is also an extra expense. Immediately, I can cut out takeaways for a quick saving. So I will do that. Maybe I can get a savings rate of 5% just from that? Also should I consider selling the car? I can use public transport, which I already do, and get rid of the expense of a car, such as tax, insurance, maintenance. This would take longer, but has great savings of up to 200/month. That is a 10% savings rate right there.
Pay off Debt
This is a simple enough decision. If you have any debt, make it a priority to pay it off. Once it is paid off, all the money going towards paying the principle and interest can now be shifted into savings instead.
It would be easy to use that extra money each year to pay for a few extra indulgences here and there, but that’s the choice you have to make. Spend it or use it to increase that savings rate and buy your time.
Savings rate is a must have in your financial independence toolkit. It keeps calculations simple and helps you track your progress towards FI. When you are trying to increase your savings rate, don’t worry about the small things, its the big expenses when the immediate changes should be made. This will have a greater impact. Once you have reduced those bigger expenses, then you can stress about the smaller ones if you like.
Anyone can increase their savings rates, just find your motivation and jump in with both feet!