Interested in achieving financial stability, independence or world domination? I’ve got a pretty complex math equation for you. Spend less than you make. Need me to make it all math-style for you?

Money made – money spent = Savings Rate

Savings rate is probably the biggest factor in achieving financial independence, unless you are a Rockefeller, a world class investor, or a generally fortunate person. For the rest of us, the amount that we can put away each week, month or year is the fuel for our financial locomotive. If you are saving 40% of what you make, you will probably reach your goals must faster than if you are achieving 10%. So why can savings rate be a confusing number for people to calculate? Many people in the personal finance space use different calculations for savings rate. I’m going to break those down for you, starting with the simplest version and showing you how you can change it from there. Here we go…

What is Savings Rate

Savings rate, in short, is the amount of your income that you put into longer term savings. It is calculated by dividing the total amount of money that you save by the total amount of money that you make. There are a couple tricky things here that lead some people to make it a more complex calculation:
  • What is considered income?
  • What is considered savings?
  • What time period do you use?

How to calculate income

Income can be calculated in a couple ways. I like to use the total amount that you are paid in salary, side hustles, checks from your Aunt, whatever. If you make money, consider it income. I prefer to use pre-tax income rather than take home pay because you have the option to set aside some of your income in tax-deferred vehicles. I get the argument for only counting take home pay, because in theory, the money that you spend on taxes isn’t really a choice, but then the math isn’t really rewarding you for investing in pre-tax vehicles like a 401k.

How to calculate savings

The next thing you have to decide is which money you’ll consider saved. The simple equation is income – spending for whatever time period you are looking at. Whether you keep that money in a checking account, savings account, retirement account, HSA plan, brokerage account, whatever…you are still saving rather than spending. Some people get hung up on whether to count things like HSA contributions or employer matching. I like to count both of those as money saved, because it is going into your account for you to spend in the future rather than being spent today. Simple enough?

What time period should you use for savings rate?

If you had a savings rate of 55% today, you may feel like you’re crushing it, but if you spend all of that tomorrow, you are crushing it a little less. I like to pick a long enough time period to measure my savings rate so that I don’t deal with the major fluctuations that naturally occur on a  week-to-week basis. I calculate my family’s savings rate on a monthly basis, then keep a spreadsheet of that going for the year. The end of year savings rate is really my guiding light for how we did financially, with the monthly numbers serving as a directional indicator. I don’t look at it weekly.

Different calculations for savings rate

Here are a few variables that you can consider when choosing how you want to calculate your savings rate:

  • Gross or Net Income – this is the difference between your total pay and your take home pay. In some ways, this would be pre-tax or post tax, but take home pay will usually also deduct things like insurance, so it’s not the cleanest picture.
  • Counting employer match as income – Do you count an employer match in savings rate or not? I do count employer match for 401k and HSA as income because it still ends up in your account. Keep in mind that if you add it to the numerator, you should also add it to the denominator so you aren’t faking yourself out.
  • Medical expenses – Do you count your contributions to a health insurance plan in savings rate or not? This kind of goes back to the gross or net income question, but I like to make sure that I’m keeping track of what I’m spending on all of my types of insurance, including medical. Most of the time, employers will also pay part of your health insurance. I typically ignore this and don’t count it as added income, because I would not have any way of choosing to spend that differently.
  • Home equity – Should you count your contribution to home equity in your savings rate? If you are paying principal down on your mortgage, you will putting money toward the equity in your home, which can be seen as an investment. You can choose to include this or not, but be careful not to include your entire mortgage payment as savings, because much of that will be interest, which is not generating equity that you will recoup in the future.

Calculation 1: (Retirement + Cash Savings) / Gross Income

This includes the total amount that you save divided by the total amount that you are paid. If you don’t have any side businesses, this would be savings divided by your salary. You can make choices on what you consider savings based on the criteria I outlined above.

Calculation 2: (Retirement + Cash Savings) / (Gross Income – Taxes)

The denominator can be seen as take home pay, or net income. This is basically giving you a view of how much of your take home pay you save. This number will appear as if you are saving more than in calculation 1, even though the top line is the same amount.

Calculation 3: (Home Equity + Retirement + Cash Savings) Contributions / Gross Income

This is the same as Calculation 1, but it includes the amount that you are contributing toward your home equity each month. This is less liquid than the others, because to access that money, you would have to sell your house, obviously.

Calculation 4: (Home Equity + Retirement + Cash Savings) Contributions / (Gross Income – Taxes)

Same thing as above, but dividing by net income or take home pay rather than gross income.

The best way to calculate your savings rate

The question of the best way to calculate your savings rate isn’t really a hill that I’m willing to die on. If you choose one of the formulas above, great! If you make tweaks to it for your own formula, even better! These calculations are strictly for your own benefit. It’s not like you have to report your savings rate to the financial independence police each month, so pick a number that works for you, is easy enough to calculate and that you’ll stick with. The key is knowing how much you are saving, setting a goal, then improving on it as much as you can each month. Hopefully this post helps you and if you have any questions, feel free to leave them in the comments and I’ll respond right away.