There are few elements of a financial plan more important than your savings rate. Get it wrong, and you’ll either be retiring later on or running out of money early. You may also never reach your financial goals. Get it right, and just about everything else will fall into place.
Let’s Start by Explaining What a Saving Rate is.
A savings rate is how much of your net income you save each month, expressed as a percentage.
For example, if you earn $ 4 000 net per month and save $ 1 000, your saving rate is 25%.
Yes, you need to base your calculation on your net income, not your gross income. Why? Because if you usually have deductions coming out of gross income, such as income tax, CPP, EI -if you live in Canada-. Your gross income isn’t reflective of what’s deposited in your bank account.
In the majority of the cases, your savings will come from your net income, not your gross income.
Financial institutions use your gross income for lending purposes so that they can make more money out of you. With your gross income, you qualify for higher amount loans than with your net income.
Now that we got this out of the way, let’s explain why your saving rate matters.
Why Your Saving Rate is important?
Your saving rate determines when and how you can retire. It also determines whether you achieve your financial goals or not, but also the time it will take you to achieve these goals.
Let’s take a couple of simple examples to illustrate how important the saving rate is.
As we have seen above, our first example is someone earning $ 4 000 net per month and saving $ 1 000 of that, i.e. 25% saving rate.
Our second example is someone earning the same $ 4 000 net per month and saving $ 2 000. It gives a 50% saving rate. With this rate, this person saves more and will be able to reach their financial goals earlier, provided they keep the same saving rate.
Yes, There are Other Factors as well
Namely the return on your investments/savings, and the time you’ve hold them for.
When it comes to saving and investing, time is on your side. The sooner you start, the better off you’ll be. Why? Because you don’t have to save as much and you’ll benefit from decades of compounding.
The return on your savings is determined by your risk tolerance and the vehicles you chose to park your money in. You’ll earn more if you invest in the stock market, than if you put your money in a savings account at your bank.
But, ultimately it all circles back to your saving rate. Your return will be higher on $ 2 000 than on $ 1 000. You’ll also have more when saving $ 2 000 per month over $ 1 000. This is just plain logic.
Case in point: most financially independent people had a saving rate of 60% to 70% to achieve financial independence in record times.
How to Boost Your Saving Rate?
Bolstering your savings rate is primarily about strategic budgeting. Here are a few tips, that may sound like a broken record, but that are all tried and true:
- Pay yourself first: when you receive your paycheck or other income, transfer a portion to your savings/retirement accounts first, before paying anything else.
- Reduce spending: do an honest review of your spending and see where you can cut. It’s not about depriving yourself of life’s many pleasures, but you do need to have some money to save.
- Increase income: you can only go so low with expenses. There are, however, no limits on how much you can make.
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