Calculating your Savings Rate: Debunking the Myths
Welcome to part III of my financial independence planning series. You can view parts I and II here:
Part I: Why you need a financial independence plan right now! (And so do I…)
How to calculate your savings rate?
As we discussed briefly here, and ad infinitum on PF/FI blogs, your savings rate is the key factor in determining how long it will take before you can cut the cord and set yourself free into the wild world (or finally watch your box-set of Breaking Bad back to back, whatever waxes your board!).
On the face of it you’d think it was a simple equation. And I have good news for you… the conclusive formula to calculate your savings rate that I arrive at, at the end of this post, is indeed very simple. As often is the case though, the journey in getting to that point was a bit of a bumpy ride. For those of you who are short on time or are simply impatient you can skip to the final answer by clicking here. For those that want to dive into a bit of theory and myth debunking* shenanigans, strap yourself and prepare for the ride 🙂
Myth One – Mr Money Mustache’s calculation
My first stop in trying to work out how to calculate my savings rate was obviously over to The Early Retirement Commander in Chief Mr Money Mustache, who in his post on the shocking simple math behind early retirement, had this to say on the subject:
Well, I have a surprise for you. It turns out that when it boils right down to it, your time to reach retirement depends on only one factor:
- your savings rate, as a percentage of your take-home pay
If you want to break it down just a bit further, your savings rate is determined entirely by these two things:
- how much you take home each year
- how much you can live on
From those words I would derive an equation along the lines of something like this:
Savings Rate SR = Amount saved / Net (Take home) Salary * 100
Example: If you took home £30,000 after tax, and you saved £15,000 of it into your savings account, your savings rate would be 50%. Easy… end of article.
Oh but hang on just one minute… This may have worked well in times of yore, before the world of personal finance became complicated with supercharged retirement vehicles such as SIPPs, ISAs, Employer matched pension contribution schemes, or 401Ks, Roth IRAs and the like if you are a US reader. Nowadays thought this clearly won’t do, and for all of us and for our lab rat, theFIRErat (please see post II in the series to view the rat’s financial figures and assumptions for all calculations), things are more complicated than this.
If we plug in the initial example figures for theFIRErat, who is making good use of the tax advantaged SIPP, into the same equation we are now looking at:
SR = £24,000 / £34,763 * 100 = 69.03%
Now you know they say when something sounds too good to be true… Well it certainly sounds like that is unfortunately going to be the case here for our unsuspecting rat.
*SPREADSHEET ALERT* At this point I could see this whole thing was gagging for a spreadsheet**, so please take a look at the column “Scenario A” in this theFIRErat Savings Rate Comparisons spreadsheet. Here is a screen shot if you can’t be bothered to load it up in Google Docs.
Savings rate Calculation Scenario A
As we can from my see a 69% savings *should* see our rat out of the race in around 9 short years, in which time the £24,000 a year contributions would compound to just £269,075 estimating a 4% real rate of return (which I am pretty sure it what the MMM post is using in his table and graph)
Now I’m no Nostradamus but even I can predict that our rat could be up the creek without a paddle if he quit with that retirement pot, and looking at the bottom row of that table “Would last X years with given expenses” we can see that yes indeed, it would only last approximately 19 years with his expenses of £20,037
Myth Two – Over 100% savings rate?!?!
Things get even more ridiculous when you consider our rat could actually pump the £20,000 into an employee retirement account before the tax man even gets his grubby hands on it. This would end up giving him a take home pay of just £20,073 (can you see why I chose that number for his expenses now people? Huh? Bueller? 😉 – There is method to my madness you see. Sometimes).
Let’s look at Scenario B in our table:
Savings Rate Calculation Scenario B
This is obviously wrong, and we can now be sure that comparing anything to take home pay just won’t do for our savings rate calculation as it just doesn’t take the tax advantaged retirement vehicles into account properly.
Myth 3 – Monevator’s calculation
Next stop on our magical mystery tour would naturally be to the excellent Monevator blog, who has this post on How to work out your own financial independence plan. The highlight for our purposes here is the following:
You probably know this number already, but just to make sure you’re getting as full a figure as possible:
- Take your annual net income
- Subtract your annual expenses
- Add all your other income streams including rentals and bank interest
- Add pension contributions and employer matches if pensions are a factor in your plan. Gross them up to account for tax relief.
- Don’t add investment income and gains. These are accounted for in the return assumptions that follow.
The number you’re left with is how much you should be saving a year. Divide by 12 for the monthly amount. Compare it to your gross income to find your savings rate. Then ratchet up the rate if you want out quicker.
OK… sounds a bit better. There is mention of Grossing up the pension contributions to tax into account tax relief! So we are now looking at a calculation of the form:
Savings Rate SR = Amount saved / Gross Salary * 100
SR = £24,000 / £50,000 * 100 = 48%
This sounds entirely plausible to me, however I will of course add a column to my spreadsheet to verify that everything checks out:
Savings Rate Calculation Scenario C
Here we can see our rat needs to save for a shade over 18 years to amass a portfolio of £650,000, and the number of years this will last him in retirement is that special magical number “Forever!”***. Not to be sniffed at! However by simply using the 4% rule on our rat’s expenses we can see that we are condemning him to a few extra working years unnecessarily:
Retirement Pot Needed = Expenses * 25
Pot = £20,073 * 25 = £501,825
Back to the drawing board!
Myth 4 – Including Mortgage Principal Payments as Savings
I was wondering whether to include my mortgage principle payments in my savings rate, and having read through this post on the ERE forum here I have whittled down the arguments to as follows:
- The argument for is thus: If I made any overpayments on my mortgage, I would definitely consider this as savings and include it in the percentage, so why not the actual part of my mortgage payment that goes to the principal?
- The argument against it is that whatever money you put into your house, it is not an income generating asset, so it will never support you.
The extreme example to prove that the argument against including it is if we consider someone who earns well and lives in a nice big McMansion. They could end up paying 40% of their “savings” into the mortgage principle, building up a nice amount of equity but never anything that actually produces passive income. In 22 years our table says they can retire but they could end up with £500,000 equity in the house and nothing to show on the retirement accounts front. This will obviously not do! They could just sell the house and live off the proceeds but I think we are safe to assume that someone who has bought such a house does not want to sell it to retire. Conversely someone who rents a much cheaper place, saves 40% into retirement accounts and builds up £500,000 in a retirement pot after should be good to go after 22 years and see no change in their current lifestyle.
There is definitely a significant value in paying off principle on your mortgage, and I will talk about that in more detail in the next part of the series when we cover Net Worth, but for now all you need to know is don’t include mortgage payments in your savings rate calculations, because the bottom line is, it totally messes them up. Spreadsheet column not even needed on this one 🙂
Myth 5 – Done by Forty can explain it to me properly 😉
So it seems I finally stumbled across the correct calculation at my blogging buddy Done by Forty’s post on his February Budget.
However even Done by Forty had a hard time explaining it to me in the comments:
Hey FIREstarter. So our method of calculating savings rate is to take our total savings (including both pre-tax and post-tax savings and any employer contributions to savings) divided by: (gross income minus all taxes). So those pre-tax savings amounts are the untaxed figures
“Gross income minus all taxes” sounds a lot like Net Income to me, which we proved was incorrect in Scenario A. However I looked at the figures in the post and it all made sense:
Total Spending: $1,620Total Savings: $10,000Savings Rate: 86.06%
Working back from that 86% figure I got the following:
86% = 10,000 / ( 1,620 + 10,000) * 100
This impressive savings figure would see DbF retire in less than four years if he keeps that savings rate up! (See Scenario E in the spreadsheet, I thought I’d add it in there for a bit of fun)
So it seems DbF knows exactly what he is doing, even though it may have come across a little muddled in the explanation he gave me in the comments. Thanks to DbF for finally showing me the way!
The only Savings Rate Calculation you will ever need!
Ok so thanks to Done by Forty I have finally found the holy grail of savings rate calculation formulas:
Where totalSavings is all of your savings whether post or pre tax, depending on whether the amount saved was post or pre-tax, and if you get tax rebates into your savings account then you count that as savings as well. So if you save £6,000 into a SIPP and get a further £4,000 rebated into it, your total savings (for that SIPP) are obviously £10,000.
In our initial example for theFIRErat this give him a savings rate of… drum roll pleeeeeeeease!
SR = 24,000 / ( 20,037 + 24,000) x 100 = 54.46%
Let’s see it on the spreadsheet one final time shall we?
Savings Rate Calculation Scenario D – The right one!
This means he should have his F-You money pot of £501,825 in approximately 15 years and 3 months, using a rate of return at 4%. This pot will provide him with his £20,073 yearly expenses in passive income perpetually, for the rest of his life.
It’s strange when you first see this equation as it turns out you don’t really need to know what your income is at all, or at the very least, you don’t have to directly plug it into this formula at all. It turns out that this is because years to FI and savings rate (%) are directly linked without need for real numbers, hence the whole point of MMM’s table and graph in his post in the first place, which you will notice did not have any hard cash numbers in it.
For those that want the equation that links the two, here it is:
Where savingsRate is a fraction or decimal greater than 0 and less than 1. So if savingsRate is 60% it would be 0.6, and 1-savingsRate would be 0.4. Please note this formula cannot factor in compound interest in it’s basic form so it is not really much use to you, but I thought it was worth including to illustrate how inextricably linked that the fractions you save compared to the fractions you spend are to the number of years until you can retire.
MASSIVE DISCLAIMER ALERT: I am still a relative newbie to this and clearly am not a financial advisor or any such thing. This article is simply running through my methodology of how I have tried to work out these formulas and on how I came to my conclusions. If anyone has any better information or can spot an error in what I have said please do let me know and I will update the article, giving credit where it is due. Thanks!
Heaven must be missing a spreadsheet
I appreciate this was a very long article so if you made it to the end, well done and thanks for reading! I also hope you appreciate that I wanted to show the why and wherefore’s of the formula rather than just tell you it straight up and send you on your merry way, especially seeing as there seems to be a bit of confusion about it out there in internetland, even on other big name PF blogs.
As a little reward I would like to share another spreadsheet which I am calling my FI Calculators Suite
This has a sexy “compound interest calculator+” which not only calculates retirement pot growth over a given number of years, but also how long that pot would last given a certain expenses figure. I’ve included four columns so you can compare different estimates of rates, savings, and so on very easily as well. It’s pretty neat!
There is also a “Years till FI” calculator in which you can add your various yearly savings figures for various accounts (SIPP, ISA, and so on) and it will tell you the number of years it should take you to FIRE (I guess the name might have given that away?). Anyway it’s pretty cool as well, there are also four sets of columns so you can compare and contrast estimates once again. I will also be adding more tabs over the coming weeks to this!
As always drop me a line in the comments to voice your thoughts!
Thanks again! TFS.x
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*I use the word “Myth” in the most light-hearted way possible here. I am not suggesting that MMM, Monevator et al are perpetuating ridiculous Myths around the internet about savings rate calculations, nor misleading any folk deliberately in any way. I freaking love both of those websites so would never say anything bad about them and actually mean it! Back ↑
**Some quick notes on how to use my spreadsheets…
- They are all publicly viewable, but you can’t edit them, so you need to save a copy to your own google drive (File -> Make a copy) or download (File -> Download As) to be able to edit/update them. If you don’t have your own google drive yet, get one now! It’s free and possibly the best productivity tool I have ever used.
- The big bright Yellow cells are the ones you can mess with and add in your own figures (or you could play around with mine to see how this affects things first, to get an idea of things)
- All other cells you generally need to avoid editing, as they’ll like contain formulas and so on. You can actually edit them, I can’t and wouldn’t stop you anyway, but I can’t be held responsible for the consequences
- On some spreadsheets I have tried to use colour coding to denote where one figure is used somewhere else, to give you an idea of what figures are linked to what. Back ↑
***A quick separate note on “Forever!” in the spreadsheets: This is not just something I’ve made up. The formula used in this cell returns an error when your retirement pot will never deplete to zero given the variables you supplied (It could just return infinity years if it was to be super useful, but for some reason it doesn’t and returns an error instead). So instead of showing an error, which makes my spreadsheet look broken, I decided to check for the error and output “Forever!” instead, which is actually much more useful to us 🙂 Back ↑
Discussion (46) ¬
I’ll have to run the numbers using this formula to see where I’m at. I’ve changed the way I calculate my savings rate. Last year it was everything that was saved from net income each month, whether it was earmarked for expenses or investing. This year I changed it so now it’s just savings from net income that is specifically for investment. Although that isn’t close to the actual money that I save. I have 8% withheld post tax from my paycheck to buy shares of the company I work for that isn’t accounted for and then the 401k contributions aren’t included either since the plan isn’t to touch them until I can withdraw penalty free. I’ll give it a looksee and see how it changes.
Sounds like you have a pretty hefty safety margin built in there then JC.
Not sure if you’ve already done the calculations but you could obviously time your taxed portfolio so it (roughly) will draw down to (near) zero when approach 59.5 which I beleive is the age when you can access 401k et al penalty free?
I will be making a post about how to optimize this tactic soon as part of the financial independence planning series in fact. 🙂
It will be focused on the UK accounts but the principle is obviously the same for the US ones.
The numbers for January work out to 72.7% and 74.4%. The higher one includes the employer match to my 401k. Not bad at all.
The plan is to keep the taxable portfolio in tact pretty much forever and not sell off assets, but live off the income they produce. The traditional retirement accounts are there more for backup, paying for grandchildren school, donating to charity once I can withdraw them without penalty. But that’s subject to change depending on what curveballs life throws our way.
“Not bad at all” – very modest my friend 🙂 I’d say that is pretty darn amazing.
I got the feeling that was going to be your plan… Nothing wrong with building all that safety to deal with those curveballs, that is for sure. Sounds like a solid plan.
I’m showing this post to my wife, so I can finally debunk the prevailing myth in the DB40 household: that I am never right. 🙂
Obviously I’m biased, but I like the way that you and I calculate it, since it covers the fairly common mix of pre-tax and post-tax savings. I still view pre-tax savings as “mine”…the only complication is what taxes we’ll eventually pay.
Fantastically detailed breakdown. Your posts remind me that I should occasionally dig into a subject, as there are subjects that warrant a long look. And great job on that guest post, too. J Money only selects the best stuff for Rockstar Finance. I’m hoping you’ll get some new readers out of it!
Ha ha… good idea DB40!
Thanks for the kind words on the post, it took me a long time to write it including the spreadsheets so glad you liked it.
Yes the taxes you might end up paying are a factor but personally I am not planning on paying any taxes on my withdrawals once I am FI. There are a few techniques for this, which yet again I am going to go over in a future post. It seems like that is all I am saying at the moment! I can’t wait for them to written so I can just give people the link if these subjects come up in future comments, but these things take time eh.
Yea that was great about Rockstar finance! That really made my day, thanks again for featuring my guest post!
Wow, that’s a lot of detail 🙂 Take a step back and look at the big picture. Your financial affairs (may) also include some other people – who you marry/partner with, and possibly any children. A life well lived sadly will also have some crises in it – being made redundant and relationship breakup are a couple of the big ones.
You need financial resilience there that such a large pension contribution inhibits. There’s a case to be made for accepting paying basic rate tax, I’d agree that any 40% and above tax is just plain rude and should be SIPPed. But you need a hedge against those sucker punches, and they often come before 55. So a little more ISA and a little less SIPP gives you options. I didn’t make it to 55 before getting so sick of working I wanted out – again, decent ISA income gives early retirees options. It isn’t just a numbers game, there is also a time axis.
You have the overall idea right, just don’t paint yourself into a corner with the laudable goal of minimising tax. Sometimes it’s okay to pay some tax to get control of your own money!
Hi Ermine, thanks for the comment!
I totally agree! I will be going over optimisation of ISA and SIPP contributions for our lab rat, and how his current age is a variable that will affect the amount he should put into each pot, in a future post coming very soon.
Great post, TFS. I’ve corrected the Monevator piece in light of your findings. My thanks to you and Done by Forty. You realise, DB40, that my original post will now be used against me in The Accumulator household 😉
TFS, am enjoying your blog very much, keep up the good work!
Thanks for the kind words TA! Glad to hear you are enjoying the blog.
Thanks for a thought-provoking article. Getting the nuts-and-bolts of one’s personal accounting right is more important than many folks realize, because if the maths is wrong, then the conclusions drawn from it will be wrong too.
A house is not an income-generating asset, but it is an accommodation-generating asset. Now, accommodation is not fungible in the way that money is, so owning a larger house than one needs is wasteful, and owning a smaller house than one needs is useless, since it completely fails to meet one’s requirements. However, if we have a Goldilocks house which is about right, then it provides about the right accommodation, and that means we don’t have to spend money on rent.
Well, the house I own is about right, so I include my equity in my assets, and my mortgage principal (not principle!) payments as savings, for precisely these reasons.
If we don’t account for housing value as an asset, then any money spent on acquiring housing has to be viewed as wasted. To me, this is bonkers — it means that taking an interest-only mortgage magically makes one richer than taking a repayment mortgage. It means that buying a house for cash causes one to immediately suffer the loss of the entire capital.
For accurate accounting, we must record mortgage capital payments as part of one’s savings. We may not be able to use all of the accommodation generated by the real estate, due to the non-fungible nature of accommodation, but we can certainly sell our real estate equity for market value, and use the proceeds to better meet our accommodation needs.
Hi Jonathan!
I actually agree with you that your house and therefore principle payments ARE actually worth something (simple logic dictates that they are as you have pointed out) but exactly how much is not immediately obvious.
I will be covering this topic in the next article which is “How to Calculate your Net Worth”. This clearly will have some impact on the savings rate calculation, but seeing as this article was already over 2000 words, I thought I would leave it out for now. I might have to go back and put in an edit once I have posted the next post, depending on my conclusions and how significant it turns out to be in various scenarios that I run (I have got the theory in my head but not run the figures just yet).
Cheers for your insightful comments!
On the issue of post-tax (ISA) versus pre-tax (pension) savings, I don’t think one can simply add them together, for they are different things. There is still tax to pay on the pension savings, when they start to be converted into income (note: not just the income they produce, but also the consumption of the capital).
£100 in an ISA is worth more than £100 in a pension fund. They are not the same types of pound.
When listing my monthly savings, I write two columns, “net” and “gross”. Post-tax savings are entered in the net column; pre-tax savings go into the gross column. Then I work out what the corresponding gross figure would be for each net item (“what would this figure be, if I’d saved it into a pension fund?”), and work out what the corresponding net figure would be for each gross item (“what would this figure be, if I hadn’t saved it in a pension fund?”). Now I can add up each column, and use the gross figure against gross income to compute a gross savings rate, and use the net figure against my net income, to compute a net savings rate.
That can provide some insight.
Hi Jonathan,
That sounds like a more accurate albeit more complicated way of calculating your percentage if you are savings towards a traditional retirement involving luxury cruises every year and buying a holiday home in Spain.
But if you are planning on living on less that 10K per year in retirement http://thefirestarter.co.uk/is-it-possible-to-live-on-10000-a-year-in-the-uk/ then you won’t have to worry about tax when you are withdrawing from your SIPP or pension (as far as I am aware anyway)
I realise that this situation is clearly not for everyone, but one of the cornerstones of this blog is about reducing your expenses while still living the good life, and I think that is easily achievable under the current tax personal tax allowance level of around the 10k mark (if you have a paid off house anyway!)
Forgive a possibly daft question, by how would I calculate my annual expenses? Is it just the total amount of money I spend in a year?
Hi Drew,
Not a daft question at all in fact and the answer depends on exactly what you wanted to achieve from your savings rate. If you wanted to plug it into the “How many years till I can retire” formula/table then your expenses are actually your projected expenses you think you will have when you retire.
The best example I can think of that will make a huge difference is in commuting, I spend £3000+ a year on a train ticket right now but that will dissapear once I am FI so I don’t need to include that in my expenses figure for this purposes.
Obviously, if you are looking at your budget right now and working out how much you can likely save each month, you need to add up the total amount you are spending right now to figure that out.
Hope that makes sense and cheers for the great question!
Whoa, I’m going to have to re-read/study this post! Retirement for a small business person is something of a fantasy although I feel like I’m finally ready to start my path toward it. I like that you have a whole series dedicated to the subject. I’ll definitely be taking notes!
Hi Sean, thanks for the comment!
Hopefully you’ll find the series useful. I’ve read on a few other blogs/websites devoted to wealth building (and consequently retiring early) that small business is one of the fastest ways to grow wealth, so hopefully you’ll be at the point where you can retire quicker than the rest of us.
I know there are other factors such as passion for the business and so on, which would keep owners working long after they could theoretically retire, which is very admirable in my opinion!
You star TFS. Not only have you allowed me to create another spreadsheet 🙂 it’s helped me to solve the % savings rate dilemma when taking into account pre-tax and post tax savings, pensions etc. End result is on a normal month I am saving at a rate of 65%, annually 68% (including annual bonus). I’ll aim for 70%, it sounds better. On the topic of housing equity as net worth, yes I do think it should be included. I *Shock horror* don’t have a mortgage or own a house, due to reasons I won’t go into detail on here now, because it would be a post with calculations as long as the one you just wrote. To put it simply I’m paying off the mortgage in 9 years, on a house I don’t yet have. So for arguments sake, if my net worth was £200k, it would be unfair to say it’s £0 because I don’t have it tied up in a house. I may hit FI and decide to live off grid, in a RV, rent in Cyprus or buy a 2 up 2 down. I can use that cash however I like, in the same way a mortgagee or home owner can by releasing their cash.
Glad you found the post useful Starla!
Yes, very interesting point about being able to release the cash if you so wish.
I think the people on the side of “don’t include it” are ones that are tied down somewhat into a certain lifestyle (e.g. kids etc) so they know they are not going to move into an RV or they know in advance they do not want to upheave and become an expat. I can see it from both sides though, and it really does depend on your situation.
Bloody nice savings rate… by the way 🙂
Hi TFS. Great post. I was struggling to calculate a definitive savings rate figure after reading MMM and other blogs then discovered this post and it’s clarified a lot. The spreadsheet is really helpful too. I may be missing something in the calculations, but does it to take inflation into account in the calculation? As I understand it, total expenses is expressed in today’s terms while the resulting retirement pot is before the effects of inflation. Unless I’m mistaken, this would mean the resulting income would be less than required to cover expenses. Would you be able to shed some light on this for me? Thanks n.
Hi nibbler!
I’ve assumed that inflation is ignored in all calculations, and the 4% return on investment is a real return which means returns after inflation. That means that say inflation was 3%, then actual return would be 7%. So it is because of that, we can ignore inflation for our purposes here, and assume the income generated will be the equivalent of todays pounds or dollars. Not sure I’ve explained that all too well but hopefully you get the gist! (Let me know if not and I’ll give it another try 🙂 )
Cheers for commenting and glad you found the article useful.
Hi TFS. Great post. But:
Maybe I’m dense, bad at math, or maybe this is intentional, but the YearsTillFI equation is giving me different numbers than what you put into your spreadsheet, and different numbers than what MMM’s post suggests.
With your scenario D, you show a 54.46% savings rate. So the YearsTillFI calculation would be:
[(1 – 0.54) / 0.04] / 0.54 = 21.29 YearsTillFI (which, according to MMM’s calculation, is closer to the expectation for a 40% savings rate).
Yet your spreadsheet example shows 15.22 years, a number that more closely jibes with MMM’s post.
Another quick example is to use a 40% savings rate (22 years to FI according to MMM). The math using your formula would be:
[(1 – .40) / .04] / .4 = 37.5 YearsTillFI (or roughly the expectation for a 20% SR according to MMM).
Are you using a different formula in your example? Am I missing something completely? Am I just bad at math? Thanks.
Hi Zach,
I must admit I came back to this post just the other day to check on the formula and that bit initially confused me having looked at it again. However the key point was in the small print:
Please note this formula cannot factor in compound interest in it’s basic form so it is not really much use to you
Therefore it is how long it would take you to reach the savings level of 25 x your yearly expenses, if you received no interest on your savings/investments (i.e. its as useful as a chocolate teapot)
I might even take it out of the post as it’s a bit confusing I agree.
The real calculation in a spreadsheet uses something similar but with the NPER function it can account for the interest received on savings.
I thought may have been a bit of overkill for this article, seeing as it was already long and probably overly confusing 🙂
Just for the record though, this is what you would stick this into a spreadsheet to get your “years to FI”
=NPER(4%, SR, 0, -(( 1 – SR )/ 0.04) )
Where 4% is your expected real yearly rate of return.
SR = Savings Rate therefore 1-SR is effectively your spending rate.
And 1-SR/0.04 would be your retirement pot, all expressed as ratios compared to your SR
(If your SR was 40% you would put in 0.4, or have it reference a cell that was already a %age then you would type 40 into that cell)
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Not important bit but I wrote it anyway so will keep:
Funnily enough I just checked that in Google sheets comparing with the same formula with “real money” figures and the two outputs were out by about 0.3 years (real money slightly lower). I have no idea why, it should theoretically just be the same.
**Actually just worked it out** – I was compounding the interest monthly rather than yearly (so 4% / 12) with my real life calculations, so the extra compounding effect gets you there very slightly earlier. So the formula is solid. No need to panic!
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Let me know if you have any further questions!
Cheers
I downloaded the spreadsheet to try it out but it appears the Current value of investments row value is not taken into account anywhere, is this accurate? I may try to mess with it a little but will need to look through your calculations first to make sure I understand them before I mess with anything.
Hi Scott,
They certainly should be taken into account, yes.
If you look at the FI Calculators Suite, then the “Years till FI calculator” and play around with the “Current Value of Investments” row, you should notice that the “Years to FI @ 4% returns”, and at 5% etc… and so on change when you change this. This should work on the left hand bit where there is two peoples entries, and on the right hand bit where there is the easy comparison of 4 different scenarios
I think the spreadsheet isn’t laid out the best in highlighting those rows as being the most important ones on there.
You may well be looking at the yellow highlighted row(s) below the main table where there is “Enter your savings rate” and “How many years till FI?” which is completely different section, where you can just enter your savings rate and the Years till FI is calc’d based purely on that. Likewise the bit underneath that you can enter how long you want to retire in, and it will tell you your needed savings rate. These do not take into account current savings* though! And in fact, I’ve just noticed that they are using the incorrect formula as highlighted by Zach above, so I will change that now anyway
*It would be very hard to include current savings for this basic calculation as would require people to input their current savings amount as a ratio of what they spend and save, which requires further calculation and/or input fields, and really you will just end up with the whole shebang which is above it anyway. I just wanted to have those two rows for people to really easily mess around with savings rate % and see how it affects years till FI.
Cheers for the comment and if none of that makes sense, you still can’t get it to work, or you have any other questions let me know!
Final note: I’ve just realised that on the “Quick Net Worth, Mortgage & FI Calculator” there is no row that I can see that accounts for current value of investments, so if that is what you meant then, apologies. I think you were talking about the other Tab though! I will update the Net Worth tab with current value, as that is obviously very important for that tab as well! And then do a post explaining what the hell that Tab is all about as I never got round to it!
Cheers!
Thank you so much for the details. I’ve saved this article to reread when I’m less tired.
I always thought Scenario A “gross” meant gross less taxes. Taxes are not otherwise accounted for. Is that not what MMM meant? Just rounding off here $24k in savings plus $20k in expenses means a “gross” of $44k (I’m assuming the rest went to taxes). $24k / $44k = 54.54%, which is pretty close to your number. Though I do like that your number takes the total savings into the assumption.
How do you factor in taxes? Thanks!
Hi Laura,
I think the confusion here is that in the UK we pay our tax upfront whilst in the USA you pay your tax after the event (I’m pretty sure that’s what happens anyway).
So when you are saying “gross of $44k (I’m assuming the rest went to taxes)” a British person would say the complete opposite, we’d say “Net of £44k (assuming the rest went to taxes)”
We only ever really talk about our Net salary, after tax has been taken off, because we never see any of the money before that. So in answer to the question “How do I factor in taxes” it is exactly in your calc of $24k / $44k = 54.54% (but then I would add in tax efficient saving back in such as ISA/SIPP (UK) or IRA/401K (US) because they are obviously still savings)
Hope that makes sense? Let me know if not!
I’m a bit confused as to why total savings + total expenses is not the same as net income.
In your example, total savings(24k) + total spending (20k) = 44k. But the listed net income is 34763. Where does the extra 10k come from? If the employer pension contributions of 4k are added back in, it’s still 6k short.
Hi Adam,
The extra is made up by the tax free part of the SIPP. So I am assuming he makes about 34763(net income) – 20073(expenses) = £14690 of payments into the SIPP. However you then get a 40% kicker for the first ~£7K due to the higher rate tax bracket falling at the 43K (may have been slightly less at time of writing but that’s what it is now) mark and a 20% kicker for the remainder of the ~£7K
So now we have a contribution of:
7K / (1 – 0.4) = £11.6K
7K / (1 – 0.2) = £8.7K
So that’s £20.3K, plus the 2K pension + 2K employer match equals your ~£24K
Obviously the figures are slightly out but I rounded them to 20K to make the numbers look a bit prettier, but they are definitely in the right ball park.
And of course if you don’t make gratuitous use of a SIPP it will be very hard to hit that kind of savings figure with the Rat’s income (I don’t, for a start, I’ve just stuck a bit in one to test the waters and get a bit of the tax rebate kicker)
If none of that makes sense please let me know and I’ll try to explain again 🙂
Wow I like this formula! I was previously using 100/take home pay * savings and coming up with 53% but this new formula boosts it way up to 73.2%! Almost three quarters, made my day 🙂
Wow, that is amazing!
I mean obviously double check that but that is a huge difference in terms of years to FI. You are talking chopping off 10 years (from around 17 down to around 7 according to MMMs chart) off your FIRE journey, which is good news to put it mildy.
Cheers!
Hi – Given this was originally written a few years ago I’d like to check whether Scenario D is still the savings rate calculation of choice? I’m late to the game but trying to get my head around it all. Thanks!
Hi Dan,
It is certainly still the best simple way to calculate it that I’ve come across, that’s for sure (and therefore the one I still use). And it will give you the number that is most easily* converted into a “Years to FI”
However many people across the FI space calculate it differently for a variety of reasons. Weenie at http://quietlysaving.co.uk/2018/05/04/april-2018-plus-other-updates/ calculates it as money saved out of her Net salary, and if you really want to get confused take a look at Wephway: https://deliberatelivinguk.wordpress.com/2018/05/03/april-2018-review/
*Throwing in a mortgage though and it makes it nigh on impossible to do a calculation in one hit. You are better off just making up a custom spreadsheet with current Net Worth, current Mortgage, interest rate, payments, and so on, and plug in your saving and spending figures into that, and then run a simulation going forward many years and seeing where your investments start to produce more than your spending (spending will in theory reduce as your mortgage gets paid down and also gets eaten away by inflation, and obviously be a fair bit less when mortgage is totally paid off!). This is something that I’ve still not quite done properly yet either… so need to get on it! A post idea for the near future perhaps.
Thanks!