You don’t have to be a math whiz or a financial expert to get a good idea of how you’re doing when it comes to your personal savings. The formula to calculate your personal savings rate (the percentage of your after-tax income that you’re putting away for the future) is pretty basic and can be used to assess your financial health.
What Information is Included in the Savings Rate Formula?
The basic formula to calculate savings rate is:
your savings / your after-tax income = your savings rate
Once you’ve calculated your savings rate, you can use it to:
• Review how you’re doing from month to month or year to year.
• See how your current spending habits are affecting your future goals and financial independence.
• Motivate yourself to do better with your savings.
• Compare your efforts to others.
You can gather up the numbers you need to determine your savings rate (which is sometimes referred to as a savings ratio) in just a few steps:
Step 1: Add Up Your Income for the Month
Your income streams might include, after taxes: your monthly salary, the money you earned from any side gigs or from selling homemade items online, or rental income if you’re renting out a room of your home to get extra funds. Don’t forget to include money you earned that’s automatically deducted from your pay and added to a retirement account, such as a 401(k) or a traditional or Roth IRA. And add in your employer’s matching retirement plan contributions, as well.
Recommended: 39 Ways to Earn Passive Income Streams
Step 2: Add Up the Money You Put into Savings Each Month
This is about what you’re saving for the long-term, not next week. So it would include the money that’s automatically coming out of your check for retirement savings, plus your employer’s matching contributions, along with any funds you’re putting into separate savings or brokerage accounts.
Step 3: Do the Math
Divide the total amount of your long-term savings (Step 2) by the total amount of your after-tax income (Step 1). Turn the number you get into a percentage (.10 is 10%, for example), and that’s your savings rate.
You may hear or see a few variations on what’s included in the calculation. Some people don’t include their employer’s 401(k) contributions in their calculations, for instance, and some might add in extra payments they’re putting toward the principal on a student loan or other debt. The point is to be consistent with what you do or don’t include from month to month.
How About an Example?
Let’s use Jane, whose hypothetical after-tax Income every month is $4,500. She brings in another $500, after taxes, by renting the extra bedroom in her apartment to her cousin, for a total of $5,000 a month.
Jane’s employer doesn’t offer a 401(k) plan, but on her own, Jane puts $500 a month into a Roth IRA. And she always puts another $100 a month in an online savings account she has earmarked for long-term goals. Jane’s savings amount totals $600 a month.
Using the savings rate formula, that’s $600 / $5,000 = .12, which makes Jane’s personal monthly savings rate 12%.
Of course, everyone’s numbers may not be quite so straightforward. Couples, for instance, may have to consider two or more paychecks and, possibly, two or more retirement accounts. Some individuals work more than one job or earn income from multiple sources. Some might count their emergency fund as savings, and others don’t. But the idea is the same: An individual’s or a household’s savings rate measures how much disposable income (defined by the U.S. Bureau of Economic Analysis (BEA) as after-tax income) is being set aside for long-term savings and retirement.
Why Is Knowing Your Personal Savings Rate Important?
The BEA tracks the nation’s personal savings rate from month to month to monitor Americans’ financial health and better predict consumer behavior. And you can do much the same thing with your own savings rate.
By tracking your rate on a regular basis, you can assess how you’re doing in real-time. If you’re consistently falling short of the savings goals you’ve set for yourself, you can look at what behaviors might need changing or if you need to rework your budget. You also can use the information as an incentive to do better. And you might even find it’s a fun way to compete with others close to you, or with the nation’s average personal savings rate, or just against yourself.
If you saved 8% in 2021, for example, could you bump that amount to 9% or 10% in 2022? What if you got an unexpected raise or bonus: would you have the discipline to put that amount into your savings to keep your rate the same or improve it?
Knowing your savings rate can help you make those kinds of financial decisions.
What’s a Good Savings Rate?
The average personal savings rate in the U.S. was about 7.5% in 2019. But financial experts generally advise savers to stash away at least 10% of their income every month ($500 of a $5,000 monthly salary, for example). The popular 50/30/20 budget rule created by Sen. Elizabeth Warren suggests saving 20% of after-tax income.
If that seems extreme, it’s probably more useful to simply target a number you’re sure you can stick to monthly or annually. Just having a positive savings rate—anything above zero—can be a good starting point for building good fiscal habits and a nest egg. You can always make adjustments as you accomplish other financial goals, such as paying off student loans or credit card debt.
Isn’t Having a Good Budget Enough?
A personal budget can be a useful guide when it comes to reaching financial goals. And tracking your spending with a spreadsheet or an app can help you see where your dollars (and dimes) are actually going, as opposed to where you think they’re going—those two places might be very different.
Many budget users include the amount they plan to put toward savings in their budget as a monthly expense. But that’s different from knowing your savings rate.
A savings rate provides a separate, wide-angle view of how much of what you make is going into savings. And that can help you further evaluate how you’re doing.
How Can Someone Improve Their Savings Rate?
The answer is simple: Spend less and save more.
Here are some steps that could help improve an individual’s or household’s savings rate.
Opening or Contributing More to a Retirement Account
One of the easiest ways to save more money can be to open a 401(k) or IRA, or to boost the amount that’s automatically deposited to an account you already have. After all, if you never see the money, you likely won’t be as tempted to spend it. And if you’re a long way from retirement, the money you invest should have lots of time to grow with compound interest. If your employer offers a 401(k) with a matching contribution, a goal might be to save as much as possible to maximize those funds.
Recommended: How an Employer 401(k) Match Works
Opening an Online Savings Account
If you’ve been saving s-l-o-w-l-y with a traditional type of savings account , it might be time to consider other options. Many online financial institutions, for example, offer higher interest rates for deposit accounts because they have lower overhead costs than brick-and-mortar banks, and they pass those savings on to their customers. Online accounts also may offer lower fees than traditional banks—or, in some cases, no fees.
Cut Back on Discretionary Spending
The thought of squeezing out additional dollars for savings each month might be daunting if you’re already on a tight budget. But even a little spending cut can go a long way toward nudging up your savings rate.
Let’s go back to our hypothetical saver, Jane, for an example. If Jane could manage to save just $50 more every month (or about $12 a week), she could increase her savings rate by a full percentage point—from 12% to 13%. That might mean getting takeout one less time every week. Or one less night out with the girls every month. Or maybe giving up a subscription service she seldom uses.
Lowering Fixed Expenses
Lowering the bills that have to be paid every month can increase the amount of money that’s available for savings. That could include shopping for cheaper car insurance or a less expensive cell phone carrier, keeping your paid-off car for an extra year or two instead of jumping right back into another auto loan, refinancing to a lower interest rate on a mortgage or student loans, cutting the cord on cable, or doing your own landscaping.
Ditching the Credit Card Debt
Yes, credit cards are convenient, and using your cards wisely can have a positive effect on your credit score. But the interest on credit cards is typically higher than for other types of borrowing, and it compounds, which means you could be paying interest on the interest charged on previous purchases.
If you’re carrying a balance from month to month and paying interest, you’re giving money to the credit card company that could be going into your savings account. Using a debt payoff strategy or consolidating your credit card debt with a personal loan could help you dump those credit card bills and get your savings back on track.
Putting Pay Raises Toward Savings, Not Spending
No one is suggesting that you should live ultra frugally like when you were scraping by in college or starting your career, but it might not hurt to hold on to some of those money-saving habits you had then. Otherwise, if your pay goes up and your savings stay static, your savings ratio is doomed to drop.
One last example using our hypothetical friend, Jane: If Jane got a $100-a-month raise (after taxes), but she continued putting $600 a month into savings, her savings rate would fall from 12% to just below 10%.
Saving money might not be considered exciting by everyone, but the thought of being financially secure is pretty appealing. Think of your savings rate as a mirror you can hold up every month to see how you’re doing.
Using just one account, for instance, a cash management account like SoFi Money®, can save some steps when beginning to calculate your savings rate. Instead of opening multiple bank accounts for different financial goals (an emergency fund, the down payment for a house, a retirement fund, etc.), you can create “vaults” within your SoFi Money account to separate the savings you’ve earmarked for various goals.
Photo credit: iStock/fizkes
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