I had a graduate email me the other day to thank me for getting him on the path to saving early (awesome email!)
He had one question though: How do you calculate your savings rate?
I then realised that I’ve never really explained in a post how you should calculate your savings rate and how I’ve set up the SNSS (Saving Ninja Super Spreadsheet) to calculate that figure.
So, here it is!
How should you calculate your savings rate?
There are two things that I care about most when it comes to calculating your savings rate – or anything else for that matter – and that is simplicity and mathematical function.
The calculation needs to work with any and all Math. It should be possible to plug any variables into the formula and for it to work out of the box, straight away.
It also needs to be simple. Anyone should be able to figure out their savings rate with minimal thought, whether they own a home, rent, have a pension, don’t have a pension – the calculation should be the same. No airy-fairy “My savings rate is N minus mortgage payments, plus equity, minus pre-tax pension payments divided by two.” It should be the same calculation no matter what assets you own or which company pension plan you are enrolled in.
Keeping it simple
The SNSS expects you to know what your average expenses are for the year. The budgeting strategy that I use, and I implore you to use as well, revolves around creating an annual budget at the beginning of the year and sticking to it as best as you can.
Doing this will allow you to allocate certain budgets to your ‘fun pots’ such as holiday and your ‘savings pots.’ It will also allow you to visualise the year before it begins and shift spending to allow more allocation to things like holidays or more to savings depending on what your current annual goal is. I’ve written a post about this method of budgeting here, and it’s vital you use this method if you want to make the most out of the Super Spreadsheet.
The benefit of budgeting for the whole year means that you don’t have to track your expenses every month, this allows you to keep your tracking simple and quick. You will, of course, lose a little bit of accuracy doing it this way, but that can be fixed.
I’ve combated the accuracy deficit by increasing my annual expenses to £12000 in the SNSS instead of the more accurate figure of £9356, this ensures that I have a little wiggle room when it comes to the uncertain expenses that crop up throughout the year. It also means that if I’m off-point, I’ll be under rather than over-calculating.
Don’t worry about all of your money
The Super Spreadsheet only cares about the money that you have invested, your monthly contributions, and your expected expenses (which you should have already figured out and added to the top of the SNSS in the ‘annual expenses’ input box).
If there is money that you have earned but not invested yet (or spent), don’t worry about it. With respect to ‘keeping it simple’, we can forget about this earning. It also isn’t useful when calculating things like ‘Years to FI’ as that assumes that everything you have saved is going to be compounding (other than your house equity).
For myself, a big chunk of my net income I don’t invest or spend. But that isn’t taken into account when calculating my monthly savings rate. I use this extra money to hoard into my Marcus account as an emergency fund. I then empty any excess emergency fund money into an ISA at the end of each tax year. This will skew my savings rate calculation for that particular month (maybe even making it go above 100%) but the ‘average savings rate’ located at the top of the SNSS records the running average for the whole 12 months, so you can use that figure to get an accurate representation of your real savings rate at the end of the year.
You should include your house in your savings rate
You should definitely be included your house in your net worth; that means that you should be including your equity payments each month in your savings rate as well.
If you were to sell all of your assets today, THAT would be your net worth…keep it simple! It doesn’t matter if you never plan to sell your home, or if you’re mortgage-free, it’s an asset.
Including your house equity (or any other equity for that matter) in your savings rate allows us to factor it into each mathematical calculation. If your home is mortgaged and your equity payments form part of your expenses, your savings rate will more accurately represent your future FI date with your home equity included. Read more into this argument here.
What’s the Math formula?
The formula simply needs two bits of information: your total expenses, and your total income – which is retrieved in the SNSS by combining your monthly contributions and your monthly expenses.
With these two figures we can do this calculation:
((Total Income – Expenses) / Total Income) * 100
So if your total income for the month is £4000 and you invest £3000 you’ll do:
£4000 – £1000 = £3000
£3000 / £4000 = 0.75
0.75 * 100 = 75
And voila, your savings rate is 75%.
This same formula can, of course, be used for your yearly income and expenses, but I just calculate the average from 12 months of savings rates to get my true savings rate at the end of the year.
What should I build?
Go and check out the Super Spreadsheet to check it out for yourselves. If you don’t want to subscribe, contact me and I’ll send it to you. I’ll be making it available to everyone when the site renovation is finished anyways.
I’m also planning to add some more features to the spreadsheet at the end of the year. What would you like to see? Do you want a way of interactively simulating compounding with graphs presentations similar to the ones I showed in this post, or are there any additional fields that you would like me to add?
Let me know in the comments below!