The savings ratio is commonly used by financial planners to provide insight into your financial security situation. The savings ratio is calculated by dividing your monthly savings (including employer match) by your monthly gross pay. Example; $500 (savings) + $200 (employer match) / $10,000 = .07 or 7%. The savings ratio is best used to judge the progress being made to achieving your long-term goals.
The savings ratio identifies how much money you save each month compared to your total monthly or annual income. Your savings ratio can be benchmarked against what is needed to be saved in order to reach your retirement goals (typically 10-15%).
What’s a good savings ratio?
The ideal savings ratio is fully dependent on your retirement goals and is reliant on the underlying assumptions you’re using in your calculations:
When do you want to retire?
How old are you today?
How much do you already have saved/invested?
What rate of return are you forecasting?
What safe withdrawal rate will you use?
These are all questions that need to be answered in order to determine what your saving ratio should be. Our FIRE Calculator is a great place to start to begin to answer those questions for yourself.
Improving your savings ratio
Now that you’ve calculated your savings ratio, you now have a better understanding of how you can manipulate the variables to improve your savings ratio. You can improve your savings ratio by increasing how much you are able to save, and by increasing your income.
Decrease your expenses
Saving more of your income is a common first step and you can do so by reducing your expenses. Most households spend a large portion of their income on discretionary expenses that are unnecessary. You don’t have to live on Top Roman, but consider where your money is going each month.
My wife and I created a barebones budget and lived that way for a month as a challenge to see what was discretionary and what was non-discretionary expenses. This showed us just how much we would be able to save if we cut back on our lifestyle and reduced our expenses. It also identified the monthly expenses that we could then use to plan our emergency fund.
Increase your income
Increasing your income is harder than decreasing your expenses, but it’s well worth the effort. There is only so much you can cut from a budget and oftentimes, people are so loaded with debt that they cannot cut much. Increasing your income can have a profound effect on your household budget and allow you to spend more, save more, invest more, and give more.
When you increase your income, you have to be cautious of increasing your lifestyle as well. It’s called lifestyle creep or silent inflation.
I’ve been fascinated by the concept of a person’s income trajectory. It’s the idea of increasing your income early in your career and enjoying a higher income during your peak earning years.
You can increase your income by:
Getting a college education
Working a second job
Earning a promotion
Learning a new trade
Starting a business
Your savings ratio is a key component of your financial independence journey and should be well understood. If you struggle with these calculations, you may want to consider seeking out a fee-only financial planner to assist you. It’s your retirement, don’t leave it up to chance. Learn about the 5 other financial ratios I recommend knowing.