The #1 Financial Independence Tool: Your Savings Rate

In order to achieve financial independence, one of the key numbers to pay attention to is your savings rate. By increasing it by just 5-10 percentage points, you could shave off years from your working career! Interested in learning more? Read on!

In this post, we’ll go over the following:

• What a savings rate is
• How to increase it
• What our family’s savings rate currently is

What a Savings Rate Is and Why It Matters

In the financial independence community, the savings rate is used as a predictor for how long it will take someone to reach financial independence. Check out Mr. Money Mustache’s infamous post about the power of savings rates here. This article shows that if you’re starting from zero net worth, increasing your savings rate from 10% to 15% (for example) could decrease your working career by 8 years. And if you doubled it to 20%, your career would be shorter by 14 years!

I know. I was floored, too. Just think of all the things you could do if you didn’t have to “work to live.” Travel more (post pandemic)? Spend more time with kids? Quit your job? Move to a different country?

There are, of course, MANY layers to this discussion, but we can all operate from the base assumption that putting more money into savings = better.

How to Calculate a Savings Rate

I calculate our savings rate using the following equation:

[pre-tax contributions + employer match + post-tax savings & investments] / [gross income + employer match] = Savings Rate

Here are more details:

Pre-tax retirement contributions and employer matching: We have a 403b and a TSP, which are the nonprofit and federal government equivalents of a 401k. We both contribute enough to get our employer match. For me, I contribute 5% and get a 10% match from my employer, while he contributes 7% and gets a 5% match.

Post-tax savings (and investments): I included all the contributions we make to our emergency savings account, Roth IRAs, our children’s 529 funds, the principal of our mortgage, and my socially responsible brokerage account (Ellevest). I view my brokerage account as an additional retirement savings tool, but that’s a strategy for another post.
Note: There’s a debate on whether mortgage principal payments should count as “savings”. I’ve decided to include ours since we do view our house equity as a way to pay for a future down payment.

Gross income and employer match: Gross income is the amount my husband and I earn before deductions are taken for retirement contributions, taxes, and health insurance. I’ve decided to add the employer match to the savings rate “denominator” because I do view it as additional income (especially because we’re both fully vested in our pre-tax retirement accounts). This also balances out including it in the numerator.
Note: Some people disregard the employer match from both pretax savings and income – whatever you do, just make sure to be consistent.

How To Increase Your Rate

This may seem obvious, but there are two main ways to increase your savings rate:

• Decrease your expenses and put the difference into the savings
• Increase your income and put the extra money into savings

Simple enough, right? Decreasing expenses is usually the easiest and first action people take, since most people are more in control of their spending than how much money they make. Also, decreasing your expenses serves you twice over: first, it increases how much money you can put into savings. And second, if you maintain your lower cost of living, then you also lower how much money you need to save to retire! Think about it: someone who can live on $40K a year needs much less to stop working versus someone who needs $100K a year.

That said, do not overlook increasing your income. While cutting spending is important, at some point there’s a dead end. Almost everyone needs to spend something in order to live. On the other hand, there’s no real limit to how much money you can earn. So once you’ve optimized your spending habits – and put all of that extra cash into savings or debt repayment – then start focusing on the other side of the equation! You can find a great list of side hustles here.

Our Current Rate

I’m excited to share that my husband’s and my combined savings rate is about 27%. For reference, the average US household savings rate (pre-pandemic) was 8%! Now, our rate wasn’t always that high. Over the past 10+ years we’ve paid off student loans, medical loans, car loans, home repair lines of credit, and revolving credit card balances. For awhile, it looked more like 2.7% than 27%! But over time, all the money that used to go to those debt repayments is now being diverted into emergency savings, Roth IRAs, and 529 funds for the kids.

We are currently increasing our savings rate by decreasing spending where we can, especially for recurring expenses. I’d like to increase my income eventually, which I’m attempting through this blog. I also occasionally sell stuff online, responsibly take advantage of credit card sign up bonuses, and am always looking for opportunities to professionally advance with my current employer.

Of course, we’re far from perfect. So starting this week, I’ll be sharing occasional financial snapshots of how we’re doing. This will include our wins, struggles, and musings. Check out the first one here! I go more in depth on what expenses we’re reducing and what we’re spending money on right now.

Moving Forward

I hope this post was a helpful gateway into how powerful your savings rate can be! Over the next few weeks, I’ll be posting more about how we all can optimize our savings and retirement vehicles, reduce spending, and tackle debt, all while still leading a life we love.