When we reviewed Mr. Money Mustache’s shockingly simple math behind early retirement, we observed that your savings rate is the most important factor in retiring early.

And it’s not just for early retirement.

Later, we looked at one of the most popular metrics in personal finance: Net worth. Again we noticed the importance of your savings rate. You see, you’re net worth is just a snapshot of where you are. Your savings rate tells you where you’re *going*.

In this post I’m going to walk you through how to calculate your savings rate like a pro. If you stay to the end, I’ll give you a free Google sheet with the formulas built in so you can just plug and chug.

**The Basic Formula**

Your savings rate is just the amount that you saved expressed as a percent of the money you made. So our most basic formula for savings rate looks like this:

Yes, if you want to be pedantic, you could point out that technically the correct formula is savings/income *100. Multiplying by 100 is necessary to express it as a percentage. I’m just going to leave that bit off and assume you realize that if you get a savings rate of .212 it means you saved 21.2% of your income.

And don’t be pedantic. Just follow me here.

The first issue we need to tackle is what counts as saving? The answer is any money you earned that you didn’t spend. So here’s our first way of re-writing the simple version of our formula:

I use the free service **Personal Capital** to track my spending and income.

So far so good?

Good. Because there’s more work to do.

**Adjusting For Taxes**

It’s pretty common when talking about personal finance to just ignore taxes for the sake of simplicity.

Well, we’re not going to do that this time. When it comes to calculating what is arguably the most important number to your financial health, you want to be as precise as possible. That means you need to think about how to handle taxes.

Specifically, you want to completely remove taxes from the picture. Any dollar you pay in taxes wasn’t yours to spend or save in the first place.

So let’s take a look at the adjusted formula that accounts for taxes and then I’ll go over what the changes mean.

**Gross Pay vs. Net Pay**

The first thing that you’ll notice is that I swapped out the phrase “income” and replaced it with “net pay.”

What’s the difference? Well, by net pay, I’m specifying that I’m only counting the money that hit your bank account.

Every time you get a paycheck, you see the gross pay at the top. This is how much your employer said they’d pay you. But that’s not how much you take home. You take home what’s left after a long string of deductions have been taken out.

We all know the basic pattern of how this looks:

The nice thing is that you don’t need your pay stub to see your net pay (although you’ll need your pay stub later). All you need is to look at the amount that was deposited in your bank account.

**Why Add Back in the Tax Return?**

Most people end up having too much taken out of their paycheck to cover taxes. The result is that when they file their taxes, they end up getting a refund from the government.

We didn’t include this money when we looked at your net pay, but it’s money that you earned and it counts as income.

It’s important to note that if you end up owing money at tax season you’ll need to subtract that amount from your income which has been overstated up to that point.

**A Note on Timing**

Technically, this year’s tax return relates to *last* year’s income. But I just count it toward’s this year’s income like I would any paycheck. Just be consistent in how you calculate it. I think it’s easier to count it as income this year.

**What About Your 401k?**

When we switched to using net pay, we left off your 401k contributions.

But that money definitely counts as income. It also counts as savings, because you didn’t spend it. In fact, you sent it directly to work for you to help win your freedom.

So let’s add those dollars back in.

Beautiful.

**Don’t Forget Insurance**

Of course, we have to add back insurance as well. Bu this one is a little trickier. It’s money that you earned that needs to be accounted for, but it’s also money that you spent.

And it’s an expense that’s not going away, even if you retire. In fact, it will probably be *more* expensive in the even of an early retirement since your employer will no longer subsidize it.

So this one needs to be added to your income in the numerator and the denominator to add it back to your spending. But it also needs to be added to your *spending*:

Why did I cross it out in the numerator? Because it appears in both income (positive) and spending (negative), so it cancels itself out.

This results in our first simplification of the savings rate formula:

Unfortunately, this is the one piece of information you’ll need to consult your pay stub to find. The rest can all be pulled from a free service like **Personal Capital**, which is what I use to keep track of my finances.

**The Final Frontier**

There’s one more tricky issue to deal with, and that’s the principal on your mortgage (if you have one).

This may be a negative cash outflow, but it’s certainly not money that you lose. The portion of your mortgage that goes towards principal is money that you are actually saving in the form of home equity.

This will eventually pay off when you sell your house and get that money back or when you pay off your mortgage and get rid of a major monthly expense.

You’ll need your most recent mortgage statement to be able to see how much you paid in principal this month (unless your a nerd with a spreadsheet that calculates it like me).

We’ve already counted your mortgage principal in our income, the problem is that we also counted it towards our spending when it wasn’t spending. So all we have to do is subtract it from spending:

And that’s it. Our savings rate formula has assumed it’s final form.

**What About Other Income?**

My take on recording other income is to treat it just like another paycheck.

I have side hustle income from various sources, and I simply record it when it hits my bank account.

The nice thing is that these paychecks don’t have have any deductions taken out of them, so I don’t need to make any adjustments. If I get a check for $100 I add it to my income and that’s that.

**Months and Years**

Like many numbers, your savings rate is only meaningful over a given period of time.

So how often should you calculate it? That’s up to you, but I wouldn’t do more than once per month or less than once per year.

Months and years are pretty standard units of time for thinking about financial matters.

Doing it monthly gives you more frequent feedback on how you are doing.

Calculating it yearly smooths out the large tax return and gives you a better picture of how you’ve done over a longer period of time.

**A Google Sheet For You to Use**

As promised, here is the Google sheet for you to use. Be sure to save a copy to your Google Drive so that you can edit it (click “File” -> “Make a Copy”).

You only need to fill in the cells highlighted light blue. Everything else has formulas to fill in automatically.

I populated the first row with dummy data just to give you an idea of what it looks like. Notice how in the column for income I used a formula to add together two hypothetical paychecks as well as $500 of side hustle income. You can use formulas like that in Google sheets to add your income from different sources up.

**What Should You Do With Your Savings?**

Basically, you have two great options for what to do with the money you save:

- Invest it
- Set it aside in an emergency fund

Investing it is putting it to work for you. It’s how you build wealth and ultimately win your freedom. But having money available in case of an emergency is really useful in the rare event that you need it.

**How Fast Are You Going?**

In the introduction to this post I said that net worth tells you where you are and your savings rate tells you where you’re going. That’s true, but it also undersells your savings rate. Your savings rate also tells you *how fast you’re going*.

Remember, in the shockingly simple math post we saw that your savings rate is the only variable you need to calculate how long it will take you to retire.

Here’s how long it takes to retire assuming a net worth of $0, annual returns of 5%, and using the 4% rule to determine how much money you need to never work again:

Savings Rate | Working Years Until Retirement |
---|---|

5% | 65 |

10% | 51 |

15% | 42 |

20% | 36 |

25% | 32 |

30% | 28 |

35% | 24 |

40% | 21 |

45% | 19 |

50% | 17 |

55% | 14 |

60% | 12 |

65% | 11 |

70% | 9 |

75% | 7 |

80% | 6 |

85% | 4 |

90% | 3 |

95% | 2 |

**Final Thoughts**

Calculating your savings rate is something that most people don’t do, but they should. It’s an incredibly powerful way to measure where you are going and how fast you’re getting there.

- Is Dollar-Cost Averaging Worth It? - March 27, 2023
- My Favorite Savings Account With Sub Accounts - March 20, 2023
- The Average 401k Balance by Age - March 13, 2023