Why your savings rate is lower than you think it is

Don’t worry. I’m sure you did your math right, but chances are that the savings rate that really matters is lower than the number you are coming up with. In this post I’ll explain the relationship between your savings rate and financial independence. And you get to know why your savings rate is lower than you think it is.

savings rate is lower than you think

A savings rate is the amount of money, expressed as a percentage or ratio, that a person saves off his/her disposable personal income. If you earn 100 000 euros and you keep 25 000 euros, your savings rate is 25%. Simple enough right?

How savings rate relates to financial independence

Your savings rate is one of the key metrics, if not THE key metric that determines how fast you will become financially independent. Mrmoneymustache wrote a seminal blog post on this topic that you must read if you havent’ done so yet. In short, the higher your savings rate the shorter your journey to financial independence. And the math is pretty astonishing.

financial independence in function of savings rate


I made the chart above based on a 4% safe withdrawal rate and 6% average returns on your portfolio during the years up to financial independence. Based on these figures it takes 39 years to reach financial independence with a savings rate of 15%. Let me rephrase that:

if you save less than 15% of your net income after taxes, you will never ever ever ever ever ever become financially independent within a normal working career.

You will either

  • A) run out of funds and have to rely on government pension / social security to carry you through your retirement
  • B) have to cut your lifestyle dramatically to cope.

And the way countries are struggling with their social security burden, I wouldn’t count anytime soon on scenario A having a happy ending.

However, save 50% of your income and you are only 16 years away from financial independence. Save more than 65% and you are done in less than a decade.

The math is simple and savers win always.

Why is your savings rate lower than you think

So far the simple things. There is a little catch to the story. Savings rate as we defined it earlier is a bit too loose.

If you are saving for a car, home improvements or new furniture, most people will consider that in their savings rate. But it won’t help you a single bit towards reaching financial independence the second you buy any of those things. The same goes for your home. Often I hear people comment that their house is their “savings”. I’m not going to quote Robert Kiyosaki on assets vs liabilities (a blog post will follow on that), but I will say that people are wrong to account for their mortgage payments on their home as savings.

The problem with considering mortgage payments in your savings rate

They are wrong for two reasons:

  • Your mortgage payment includes the interest on your outstanding principal. You are renting money from the bank to buy your home (and not have to rent :-). So at the very least you should clean out interest payments in your calculations.
  • Owning your home still does not produce liquidity and does not put food on the table. The only way to create liquidity is by renting out rooms or selling the place. I don’t know about you, but that is not exactly how I envision financial independence.

In short, having a savings rate of 40% does not bring you a single day nearer to financial independence if all those “savings” go towards your home or future expenses.

I still choose to consider the principal portion of my mortgage payments as savings for the two following reasons.

  • I know that as soon as I own my house in full, I will be able to set aside an equal amount of cash towards my investments without any effort. So at the very least it is an indication of how much I will be able to save later on.
  • At a later age, I should be able to sell my home and have the saved up amounts released to me.

I just need to keep in mind that this portion of savings won’t help me retire early. But it will help increase net worth. The same reasoning goes for reimbursements on loans. Once your loans are paid of, you should in theory be able to continue saving the same amount towards retirement. Paying back your loans increases your net worth, but as long as you are making those loan payments , reaching financial independence will be difficult.

Calculating a savings rate that matters

The only savings rate that really indicates how fast you will be retiring is what you set aside in income generating assets (I definitely need to post about Robert Kiyosaki soon).

Caveat: you could argue that putting money in your retirements account clearly helps funding your financial independence, but in many countries such accounts cannot be accessed before a certain age without paying hefty fees. So while this portion of assets helps you build wealth and funds financial independence, it will not help you retire at 40.

I choose to calculate savings rates in the following two ways:

  • Gross savings rate: these are all the sums going towards my investments, retirement savings, principal portions on mortgages and personal loans. I.e. this savings rate takes into account everything that increases your net worth.
  •  Net savings rate: the same as above excluding principal on mortgage and personal loan payments. This savings rate indicates how fast I am becoming financially independent.

I have chosen the terms gross and net savings rate. Paula Pant from Afford Anything expressed a very similar reasoning this blog post. She chose the term investment rate to differentiate between what people generally call savings rate and between the metric that really matters when you want to retire early. I really like that too. As I was researching this post it was great to stumble on her material and read this. I have continued reading Paula ever since and I’m an avid listener of her podcast.

Wow, two savings rates to calculate! That’s difficult, dude.

No it is not. I formatted the calculation in my excel budget once. A few copy-pastes and voilà… I am tracking these two metrics at any given time.

How have I been doing in building wealth and financial independence?


why your savings rate is lower than you think it is

Well I started out pretty average. As a young professional, I hovered around a 20% savings rate and I was really proud of myself and I figured everything was under control.

In 2012 I decided that I had enough of being so “poor” in comparison to the money I was making. I came into contact with the teachings of Mrmoneymustache and Sam at Financial Samurai and bumped things up dramatically.

2013 was pretty decent given that my daughter was born that year and we had many additional expenses.

In 2014 I purchased a home and in Belgium the purchase of a property is heavily taxed (you’ll pay about 15% on the value of the property in registration taxes). So while I still built up some net worth, I converted liquid assets into equity in my home (decreasing my net savings rate). Overall a decent year.

In 2015 and 2016 I did an MBA and managed to end 2016 in relative decent shape considering I have cash flowed a substantial part of the program.

As I look back on this I notice how rocky the past few years have been. And I’m looking forward to making decent progress again in 2017 with my net worth. I aim to achieve a gross savings rate that is above 50% and add a nice amount to my wealth. But I also plan to pay back my remaining student loans (25 000 €/26 400$) this year. My net savings rate (or the % I will be setting aside for retirement) will sit at only 0%. I’m cleaning out my closets in 2017.

From 2018 and onward, fingers crossed, I should be on a decent path to financial independence. We’ll see. Life has taught me that things never happen according to plan. But at least I have a plan.

So what about you?

How are you calculating your savings rates? Are you happy about your savings rate? How far is financial independence away for you? Please share your thoughts in the comment section below.

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