Savings Rate - The Secret Sauce to Retire Rich

Hey, what's up everyone and welcome to the School of Personal Finance. In today's video, we're going to be talking about savings rates. So now calculating and tracking your savings rate is probably one of the most important metrics when it comes to personal finance, especially if you are looking to retire early or make a big career change in life. The higher your savings rate, the more of a possibility that that becomes a reality. So in this video, I'm going to go over exactly how to calculate your savings rate. There are a bunch of different ways that you could do it. So I'll show you a couple different options, but you know my motto when it comes to all this stuff. I want to keep it as simple as possible so that you could actually take action on it and implement the things that I'm talking about in these videos. And I'll also go through what I think are the most important factors and just have a discussion around it to open your eyes to the whole concept. All right, let's get to it. So just real quick, I'm still in the process of creating the School of Personal Finance Learning Center. I'm putting together a bunch of courses. I'm going to have monthly webinars. I'm going to have quizzes and PDFs that you could download. I'm going to have monthly office hours as well, accountability, Zoom calls with people that are members of the community. So if you would like to learn more about that, make sure to check out schoolofpersonalfinance.com, get on my email list, and I'll send it out to you as soon as I have it all up and running. All right, so savings rate. What is a savings rate? So very simply put, it is just the percentage of your income that you are currently saving and investing. So the way that I like to calculate it and the way that I'm going to walk you through that I think you should use is what's called the net savings rate. And that is when you take your income, so your gross income, but you subtract out the taxes that you pay. All right, so your federal income taxes, state income taxes, your FICA taxes, you subtract that out. So a simple example, if you make $125,000 a year gross, if that's your salary, you subtract out the taxes. Let's say that you pay $25,000 a year in taxes. So now your net income is going to be $100,000 a year. Then we look at all your different savings. So we look at the savings that you do in your 401k plan, the savings that you do in your Roth IRA, in 529 plans, in HSA accounts, in a taxable brokerage account. We add all of those up together. Let's say that you save $20,000 throughout the year between all those different things. Include your employer match in there as well. So let's say it's $20,000. Then your savings rate, it is 20%, right? You're saving $20,000 out of $100,000 income. So that would be a 20% savings rate. And that would be how we calculate your net savings rate. If we compare that to what some other people use, which is your gross savings rate, that's when you just take your gross salary. So if we say it's $125,000, and then we go ahead and we look at all those different components, the money that you're saving, we get to that same $20,000. So now we're dividing $20,000 into $125,000 of gross income. So that would only be a 16% savings rate. So you can see the way that you calculate it, it does make a big difference in the actual output that you get, in the actual savings rate that you get. That's why I say it's not a great comparison tool, because you just don't know how the other person is calculating it. The way you should look at it is you are competing against yourself. You want to increase your savings rate. Always use the same way that you calculate it. And you just want to increase it each and every year. And there are other things that people could throw in there. I know one popular one is to put in the principal that you pay towards your mortgage. So you could look at how much principal you pay through the year, pay down your mortgage, and include that in your savings rate as well. And I actually do that also. I am a fan of that. Because if you're comparing to renting, with renting, if you have the same payment, you're not building any equity. You're not paying down any liability when you are just paying rent. So by paying that principal piece of your mortgage, it is increasing your net worth. It is savings that is going towards your future. And now this metric, the savings rate, it is very popular and tracked very closely for the FIRE community. So the FIRE community, it stands for Financially Independent Retire Early. And this is for people who want to try to retire from their nine to five jobs as quickly as humanly possible. It doesn't mean they're going to retire right away. Maybe they're going to go start a different career or start their own business or do something that they're passionate about. It's just for people who are trying to figure out, how much money do I have to save each and every year to get me to the point that I could basically hand in my resignation letter and be okay? Even if I didn't get another job, how would I be able to go ahead and do that? So by calculating your savings rate, this is what people use to figure out how many years they have left before they hit that point. And if we take a step back and we look at it from the two far extremes, for example, if you save 100% of your income, if you have 100% savings rate, then you don't need to work anymore, right? You don't depend on that income. If you could save 100% of it, then you have other income sources that you are living off of. If you save 0% of your income, then obviously you are going to have to work forever, right? Because you're not going to have any money saved where you're going to depend. You depend on all 100% of that income. So those are the two extremes. Now this concept of savings rate, it really started becoming popular back, I believe it was like nine years ago, when Mr. Money Mustache, who is a very popular blogger in the FIRE community, came out with this post, the shockingly simple math behind early retirement. And I'll go ahead and I'll put a link down in the description below. But in that post, he basically showed the mathematical formula that you could calculate on your own to see how many years it will take you to retirement, depending on your savings rate. Now, many of my videos, I talk about turning the lights on and knowing your numbers, knowing how much income you have coming in, how much expenses you have going out. And the difference between those two, I always refer to as the happy gap. So this is similar to that. The bigger that happy gap is, the bigger the gap between your net income and your expenses, that gives you that pool of money that you could then go ahead and invest for your future. So it's kind of the same idea. It's like that would be your savings rate, that percentage that you have left over that you could then go ahead and save and invest for your future. Now, many financial advisors and personal finance gurus like Dave Ramsey recommend a 15% savings rate. But honestly, that's if you're looking to retire in like your mid-sixties. So if you say 15% from the time you start working all the way into your sixties, that should be a long enough time to accumulate enough money that you could go ahead and retire. Then you throw social security into the mix as well, and it becomes a possibility. But I'm going to go ahead and I'm going to show you a chart here, which was also referenced in that Mr. Money Mustache article that shows you a graph of different savings rates and how many years it would take you to retire depending on the savings rate. So now the savings rates in the United States have been on a pretty steady decline over the last 50 years or so. After 2009, they started to trickle back up again because usually when you go into a recession, people start to save more of their money because they're worried about running out of money or if they lose their job or something. Also, I don't know updated numbers since COVID, but I think since COVID, people have been saving much more money plus all the government stimulus and everything. But the average before COVID was around 6% savings rate for people in the United States. So if we look at this chart, we could even see right here, he has all the different countries and what their average savings rates are. So for the US for 6%, that would mean that it would take you 62 years before you can retire. So if you think of somebody starting to work at age 21, that would bring you to age 83 before you can retire. So the reason that people could retire earlier than that is because of social security or because of pensions that used to exist that don't exist anymore. So as we could see going forward, 6%, it's just not enough. You're just not going to have enough save for retirement if you're only saving 6% of your income. All right, so now let's try a 50% savings rate. So you make 150 grand, you're able to invest and save half of that. So $75,000 a year, that means at a 50% rate, it would take you 16.6 years before you would reach financial independence and be able to go ahead and live on your portfolio at a 4% withdrawal rate for the rest of your life based on all these other assumptions. So now saving half of your income, I mean, it sounds like it's doable, right? It's like if I would only need to work like less than 17 years, I'll bite that bullet, I'll save half of my income. But unfortunately, life doesn't always work out that way. But like with all this stuff, there's so many variables, so many things that could go wrong or go better than expected that you just don't know. Like your rate of return, I mean, who knows if the assumptions that we're using here are realistic. So many things could happen. Or your cost of living in retirement, who really knows what that's going to look like once you do retire. Your expenses might drop dramatically. Some people, their expenses go up in retirement because they decide that they want to travel and really live it up once they retire. So all those things kind of come into play. How much money you currently have now, what age you are, all these things play a big part. And definitely when looking at the savings rate and trying to retire early, it's much more, in my opinion, it's much more realistic for somebody who's 22 years old to go at this, laser focus and try to start saving 70% of their income and living well below their means, living frugally, especially before they start a family. It's great to get a good head start with all of this stuff and save like an animal right out of the gates and do the best that you can because it will really set you up for later on in life. But to make these huge adjustments at my age, in your 40s, when you're already established and you have a family, I find it very hard for me to increase my savings rate from say 20% up to 50%. I would have to have some drastic life changes if I was going to happen. But once my kids are gone, then it's a different ballgame. Then I can downsize my house. My costs will go down big time. So there's a lot of moving factors in here. But the point is just looking at this stuff, it opens your eyes. It's going to help you to realize what you should be doing more of, maybe where you're lacking a little bit and just help you get focused and do better with your money. All these tools, that is the point of it, is to help you get better with your finances and with your money. But now shifting your mindset away from, I need to cut expenses, I need to spend less money, and instead looking at it like, I need to increase my savings, I need to increase my savings rate. To me, it just makes it more enjoyable. I could get more enthusiastic and motivated behind it if I have a goal, if I have a savings rate goal that I'm trying to achieve. So that's why I think it's actually very important to calculate this for yourself and see how much money am I actually saving for my retirement. Now things like social security or if you have a pension, yes, they're going to play a big part in all of this and it definitely reduces the burden of how much money you have to save if you're going to get a pension. But just don't worry about any of that stuff right now. Just for now, calculate your savings rate, see how you're doing, and try to increase it, even if you just do it a small amount. And automatic increases are obviously the best way to go. Like with a 401k, every time you get a raise, you just automatically increase it. Try to increase that savings rate, the amount of money that you have going into it. But if you shift your focus to increasing that savings rate, nothing but good things could happen to you. You're going to be focused on your investments, you're going to be focused on growing your net worth. It's going to be all great things. It's the people who are in the dark, who don't even look at this stuff. Those are the ones that we really need to worry about, that they're not going to have any money once they reach retirement. So I hope that you found this exercise helpful, and just the description of savings rates and how it all works. Please make sure to hit that like button if you enjoyed this one. Subscribe to the channel if you haven't done so already. And I'll see you again in the next video. Thanks.