What is a Savings Rate and Why is it Important for FIRE?
First, a Savings Rate is basically the percentage of money you’re saving* from your after-tax income. So if you make $100k, pay $30k in taxes, your net is $70k. Saving $19,500/yr (the current maximum contribution limit for 401(k) plans) gives you a Savings Rate of 27.8%. You’d be doing pretty well, considering the Bureau of Economic Analysis puts the savings rate for working adults in the US around 14% as of this writing.
*To be clear, note that this “savings” should be invested. I’m not advocating literally putting it in a savings account, we’re just using “Saving” as shorthand for “money you’re setting aside for retirement.”
It’s important because if you know nothing else, this single number will dictate when you can retire. I first encountered the concept on MMM’s “The Shockingly Simple Math Behind Early Retirement,” and it’s fresh on my mind because I constantly see FIRE and DebtFreeIG posts on Instagram. That coupled with this WalletBurst post (quickly becoming one of my favorite FIRE peeps!) on living “cheap” in the SF Bay Area, I decided to sit down and try to figure out my own.
MMM does a great explanation on his site, but the gist of it is “if you’re saving 0%, you can never retire; if you’re saving 100% you can retire right now” – and every % in between those two is a set number of years, assuming you start with zero dollars and are using the 4% Safe Withdrawal Rate. To be clear, everyone has a savings rate (even if it’s 0%). A Savings Rate for FIRE is anything that will let you retire *early.* So for a 22yo, a rate of ~47% would let them retire at 40. Wait until age 33 to start and retiring at 40 would require a Savings Rate closer to 75%.
Why Do I Feel Like I can Ignore Budgeting and Focus on my Savings Rate for FIRE?
In short: I’m lazy. I haven’t made a budget in many many years, I honestly have no idea what my spending even *is* (though I admit I should at least get a handle on that). The longer version: my income & tax situation is complicated. Because my main source of income is 1099 contracting, and because I pay taxes quarterly (sort of), I don’t have the tidy steady/consistent numbers of a salaried W2 employee. While someone on W2 will have 24 equal paychecks throughout the year and maybe be +/- a bit at tax time, I’ve had months where my net was $4k and months where it was $20k; and I’ve either owed or gotten back $12k at tax time on different years. My finances just don’t lend themselves to budgeting in the traditional sense.
But because of the mathgic of Savings Rates, I don’t really need a budget! This is all based on percentages. It doesn’t matter whether you’re making $35k, $100k, or a million dollars a year. If you start with nothing and save 50% of your income, you can retire with the same lifestyle after ~16 years.
I think it was once again MMM where I encountered the concept of saving over budgeting. Basically, a budget says “I can spend X amount of money and then once I hit X, stop spending until the budget resets, then I can spend X amount of money again.” Instead, flip that and focus on the “pay yourself first” method. Save/invest as your *first* priority, and figure out how to live on the money that remains.
Figuring out my Savings Rate for the Last 3 Years
When I was active duty, and for much of my W2 career after that, I figured I was doing fine. I usually put 10-14% into my TSP (then 401k), and for the last few years of my salaried career I was maxing out my 401k. The problem is, based on the math we linked earlier, that puts my working career at somewhere around 47 years. Even starting out at 18 or 19 years old like I did, that means I could retire at…65. I mean, it beats working ’til you die, but that’s just not for me.
Since I don’t have a tidy fixed percentage going to a 401k (the rules for SEP-IRAs are generous but complicated), I set about trying to go through QuickBooks and determine what my net pay has been for the last 3 years I’ve been self-employed, and then calculate my Savings Rate based on the contributions I made.
Like everything FIRE, there are a dozen different interpretations of this. Some people include bank savings accts, mortgage principal, cash, etc. Some strict budgeters actually just subtract their budget from their take-home and whatever’s left is their savings. Obviously not an option for my wildly variable income & spending.
The Math
For 6-month periods going back 3 years (I billed my first hour on 1 July 2018 so this works out nicely):
A: Add up all the invoices paid in that period (I use cash flow accounting and NET-30 billing). $10: This is my total income.
B: Add up all the IRS and State income tax payments I made during that period (it works out to Jan-Jun being tax heavy because of the way quarterly estimates are sent in). $3: This is my total tax.
C: Subtract B from A. $7: this is my net.
D: Add up all the vanguard contributions I made during the period (I’m not counting anything other than vanguard contributions. Any savings acct/etc is not really part of my retirement strategy). $1: This is my savings amount.
E: Divide D by C. 14.2%: this is my Savings Rate.
Not the actual numbers, but the math looks like this:
The Results
For the first time, I finally have some idea what my *actual* savings rate is! My place is to just update this every 6 months since it fits my income/tax model better.
I averaged about 16% for 2019 and 2020, but as you can see, the first 6 months of 2021 have spiked to 55%. So my average savings rate for the last 3 years works out to 28.9%. It’s no coincidence that the massive uptick in savings has happened during the same time I started writing this blog and getting involved in the FIRE & DebtFree communities. I’ve always known the concepts in the abstract and sorta half-assedly tried to prepare, but 6 months of buckling down has had a radical impact on our FIRE prospects.
In real dollars, I’ve actually invested more in the first 6 months of 2021 than in each of 2018, 2019, and have hit about 92% of what I invested in all of 2020!
The Caveats
Again, this is strictly automated weekly investments into Vanguard. It also doesn’t include minor other income (which I’m not touching) or minimal cash savings. I feel pretty comfortable that this is as accurate as necessary if not to the decimal point.
The major caveat here is it doesn’t include any of Mrs Jarhead’s income or savings. That said, she earns plenty, saves plenty while paying off massive debt, and realistically we should be able to FIRE with just this plan, her efforts will shave additional years off of our working career.
What’s your Savings Rate? If you’re happy with it, do you still bother budgeting?