Savings rate isn't something that's necessarily complicated, although, depending where you look, it might sound like it is. It's how much money you're able to save in relation to your income minus taxes and spending. I came across the following formula a few years back that might put it in better perspective:
gross = taxes + spending + saving
gross - taxes = spending + saving
gross - taxes - spending = saving
saving/(gross - taxes - spending)
Basically, what that's saying is that your savings rate is the percentage of everything you save after all of your expenses have been deducted. (Clearly, the above formula uses gross salary.)
There are those out there who use net income instead of gross income. I prefer to use my net income because I've dialed in my taxes so I usually owe just a little bit of money come tax time. That eliminates the tax portion from the equation. As for my spending, I've already created a budget and whittled it down to bare necessities and a few small luxuries so life is still enjoyable, which takes care of the spending portion. (Note: I think that anyone with the goal of reaching FI in a timely manner should constantly be monitoring/tweaking a budget to prevent complacency and, therefore, lifestyle creep.)
This means I track every pay and bonus check toward net income (the government has already taken their cut). I pay rent, gas, groceries, etc., which covers the spending portion. Then I transfer large portions of my income into high-yield savings accounts or investment accounts. Tracking all of the money I receive and what I choose to do with gives me a clear map of where that money is going and, therefore, greater control over it.
Now that I know exactly how much money is coming in every pay period/month/year and how much of that is going into savings/investment accounts allows me up to track my SR easily. So, let's talk about why this is important.
It's my opinion that one's SR is everything! The higher the SR you have the sooner you will reach FI. It's that simple.
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| Saving 10% vs 30% vs 60% makes a huge difference |
Previously, I discussed cutting expenses vs raising income (or doing both). Essentially, one can only cut their spending so much, so it makes sense to do that first and then focus on increasing one's income. But, what if you can't increase your income? Maybe the highest income you'll ever achieve is 30k a year or 50k.
Let's say you currently spend 24k a year and bring in 40k a year. If you've managed to wrangle your spending into control and it's relatively consistent, you'll be able to save the remaining 16k. That's an SR of 40%. Not bad. It means you would need 600k to reach FI (as defined by having 25 times your annual expenses, so 25 x 24k). If you never received a raise and maintained those annual expenses indefinitely, it means it would take you about 21 years to reach FI (calculator).
Hopefully, you're able to increase your income at some point. So, let's assume you maintain annual expenses of 24k, but you've managed to increase your salary to 60k. Now, you're able to save 36k annually. A 12k increase. Your SR is now 60%. You've reduced the time it will take you to reach FI by about 9 years! (calculator)
Imagine 9 fewer years of having to wake up to an alarm clock, commute through traffic to a drab cubicle where you spend eight (or more) hours staring at a computer screen or sitting in meetings for projects you are barely involved with. Instead, you get back 9 years of living life on your terms, whether that be doing opposite of the above or exploring other options. Pretty sweet when you stop to think about, right?
As my simple example demonstrates, one's SR has a huge impact on when they can reach FI. I chose the salaries above because I wanted to illustrate that a more common salary can still achieve FI, just as well as someone making six-figures. Sure, it could take considerably longer for someone making less, but it's achievable nonetheless. One way to increase one's SR is to minimize (if not completely avoid) lifestyle inflation.
Lifestyle inflation could be the topic of its own post, but it's ultimately up to each individual whether they succumb to it. If you receive a raise and choose to spend all of it instead of saving it, that's up to you. However, I would strongly encourage anyone to seriously consider banking that money. I'm sure their future-self would greatly appreciate it. Especially on those morning when it's hard to drag yourself from a comfortable bed to make that trek into a place you'd rather not be stuck for eight (or more) hours doing something you'd rather not be doing.
