Today I want to talk about the TWO things near and dear to my heart. Two things that can turbocharge your financial journey more powerfully than you ever thought possible. Savings rate and time. Powerful change starts with these two items and it is so important to understand these two factors because they’re CRITICAL to creating financial stability and possibility. Along with a healthy money mindset, savings rate and time are the cornerstone tools in your financial toolbox.
Savings Rate
Your savings rate is the amount of money you’re able to set aside each month for your future financial goals. After your monthly expenses, how much money do you have left over? That left-over money is set aside for long-term future goals, like retirement.
Your savings rate can be increased by two things:
- Spending less
- Earning more
Spending less is often the initial action people take, but increasing your income can’t be forgotten, either. Those two levers, when pulled together, can be incredibly powerful when it comes to your savings rate each month.
Understanding where you are today with your savings rate is important, and we can do that quickly with an easy calculation using last month as an example.
Savings Amount
Looking at your bank statements from last month, answer the following questions: How much money did you have left over after all your expenses? How much money did you transfer to savings or put toward your 401(k) or other investments? Add up that total amount.
Remember that your savings rate is a long-term metric. It’s geared toward helping you understand where you are with long-term goals like retirement. When you calculate your savings rate, don’t include any money you’re socking away for short-term goals, like an emergency fund or a new car.
Gross Income Amount
Again, using last month as an example, pull up your pay stubs. You may need to access an online system to download or request these from your HR department. What was the gross pay amount on your paystub? You may have been paid twice, or may have gotten some cash from a side hustle. Make sure to add up all income for the month.
Now, divide your savings amount by your gross income number. There we have it — your savings rate for last month.
Here’s an example calculation for reference: Deirdre makes $2,500 per month as a receptionist. Last month, she put $200 aside into her 401(k). She also contributed $85 to her Roth IRA. $285 / $2,500 = 0.114. That’s an 11% savings rate.
Why is it important to understand your own savings rate? Because your savings rate determines how many years you will need to work until you can retire, and it’s also a key factor in determining how much money you’re going to retire with.
Check out the below chart. This is from Mr. Money Mustache’s Shockingly Simple Math Behind Early Retirement. A must-read if you haven’t read it yet. In fact, Mr. Money Mustache’s entire website should be considered essential reading for all.
This chart is based on a couple of assumptions, listed below the chart. Check out the difference a higher savings rate can have on the number of years you have left to work! In fact, if I haven’t convinced you yet, please know, your savings rate is THE ONE thing that will have the biggest impact on your financial future.
Chart Assumptions:
- You can earn 5% investment returns after inflation during your saving years
- You’ll live off of the “4% safe withdrawal rate” after retirement, with some flexibility in your spending during recessions.
- You want your “Stash” to last forever, so you’ll only be touching the gains, since this income may be sustaining you for seventy years or so. Think of this assumption as a generous safety margin.
From our example above, if Deirdre keeps her 11% savings rate, she would have approximately 50ish working years until she’s able to retire. Not bad, but using the chart above, if she increases her savings rate marginally to 20%, she will shave 13 years off her working life. That only requires her to save an additional $215 per month.
Here’s another tool for you to play with, in case you’re curious about your own numbers. This site helps you calculate the number of working years you have left based on your annual expenses, income and savings rate.
These examples can be incredibly inspiring and motivating, but on the other hand, (I know!) they can also make you feel like the road ahead is L O N G. I get it. Remember, with only a few changes, you can easily increase your savings rate and begin taking steps to accelerate your journey down that road.
You don’t have to change your lifestyle overnight, and it doesn’t have to be painful. It really is possible to save money without depriving yourself. But remember, incremental changes add up along the way. Try increasing your savings rate just by 1% each month until you get where you want to be.
Related post: How to Minimize the Three Biggest Expense Categories in our Budget
With this knowledge, it’s clear that tracking our money and finding ways to cut our expenses can have huge results on our financial journey! The other thing that becomes crystal clear here is the impact of debt on your financial journey. When money is required to be funneled to a debt, it decreases the savings rate you can claim.
The great thing about your savings rate is that as you save more money, you become more comfortable living on a smaller amount of money. This means when it comes to retirement, you’ll actually need LESS to live on, which in the long run, decreases your working years even further!
Time
Alright, so if you’ve made it this far, there’s still an elephant in the room. You’re probably thinking, “I’m only 25 (or 30, or 35, etc.)! I have years and years before I even have to start thinking about retirement.”
That may be true, but you’re forgetting the significance of our second key point here – TIME. Your savings rate is important, but without that special ingredient of time, you’re missing out on some key earnings.
Why is time so important? Compound interest, y’all. It’s MAGIC. Compound interest means that every dollar you invest works FOR YOU. If you invest $1,000 and earn 8% interest in Year 1, you end the year with $1,080. In Year 2, your interest is calculated on $1,080, not your original $1,000 so now you’re earning money on the money you earned! W I L D.
Here is a calculator that can help you figure out how much compound interest can impact your financial plan.
Let’s check back in on Deirdre to see how compound interest can help her out. At age 30, Deirdre decided to invest $1,000 initially. For every month afterward, she contributed $500. If the investment account earns 6% interest annually, by the time she turns 60, she will have $480,092.61.
Her total contributions? Only $181,000.
Thanks to compound interest, her money WORKED FOR HER and gained more than THREE HUNDRED THOUSAND DOLLARS. That’s money she never earned, never worked to invest. She simply started early enough that her money earned money.
Pretty cool, huh? Now, on the flip side, maybe Deirdre waited until she was 45 to start investing. She still wants to retire at 60, so she only has 15 years to benefit from compound interest. With all of the same contributions, she will only have earned $142,052.38 after 15 years.
Another great example of the value of time can be summed up in this chart, from J.P. Morgan Asset Management. Even though Susan invested the least amount of money in this example, her investments resulted in significantly more money because she STARTED EARLY.
Let’s say it louder for the people in the back: The sooner you start on your financial plan, the easier the road and the better the gains.
Please hear this from me today! Your savings rate and time are the two key factors that can turbocharge your finances. Here are the two things I need you to do: (Run, do not walk.) You need to start NOW and you need to focus on getting your savings rate UP.
It’s a favor to yourself and to your future to get a plan in place now. Tell me in the comments what steps you’re going to take to increase your savings rate.