Your savings rate (commonly abbreviated as SR) is arguably the single most important variable on your quest for financial independence. It may seem obvious that the more that you save, the earlier you can retire, but the first time I saw just how early I could retire by saving a third or more of my income, I was completely blown away. Likewise, seeing how much shorter my career would be by squeezing an extra 5-10% into my SR really helped motivate me to be more frugal.

Once you know how important it is, it’s almost like a game to regularly crunch the numbers and try to see how high you can push your savings rate, especially in those first few years of pursuing financial independence. Who *doesn’t* want to retire even earlier? It’s also a great metric to gauge your own progress as you learn how to keep more of your money, and a bit of a bragging point in the FIRE community (though be careful not to go overboard with comparing yourself to others)!

That’s enough of a teaser introduction — why don’t I just *show* you how important your savings rate is? To that end, I created this fancy graph in Python which compares your savings rate to how many years you’ll have to work until reaching financial independence. I ran the numbers at several different rates of annual real returns to help visualize a range of expectations. Since stock market returns are highly volatile, the shorter your career is, the more likely it is that returns over that period will deviate from the average return.

I’m also assuming a starting point of $0, and defining financial independence as the point where your portfolio becomes large enough to sustain a 4% Safe Withdrawal Rate (SWR). That is, it’s very likely that if you only sell 4% of your portfolio value each year to cover your expenses, it will grow equal to or faster than this rate, allowing you to sustain such withdrawals indefinitely without running out of money. A 4% SWR also translates into a portfolio value of 25x your annual expenses.

You can click to enlarge the graph!

Isn’t that totally insane? If you could figure out how to save and invest 1/3 of your income at a 5% annual real return, you’d only need to work for just under 26 years before reaching financial independence and having the option to retire early. Even crazier, if you could save exactly half of your income, you’d only need to work for 16.6 years! And if you’ve got the right combination of income and frugality to save 2/3 of your earnings, **you’d only need to work for 10 years**.

Using the graph we can see the range of expectations that I alluded to earlier. I think defining a 0% real return (i.e. your money only keeps up with inflation, but otherwise sees no growth) as a worst case scenario is fair. Conversely, a 10% return could be used as a proxy for your working years occurring in an outstandingly good period for equity investors.

To explore this example, let’s take someone who saves 50% of their income. Our absolute worst case scenario still has them retiring in 25 years, and in our best case scenario they retire after just 13.1 years. Additionally, we can see that the higher your savings rate gets, the tighter your projected outcome range becomes! For example, moving from a 50% to a 66% savings rate, the difference between the best and worst case scenarios roughly halves, to only 6 years. I would definitely plan for the average here, but it’s helpful to look at best and worst case scenarios so we can frame our expectations.

If you’ve read some of my previous posts, you’ll know that I like to use 5% annual real returns for my projections. This is slightly less than the historical annual real return of a globally diversified equity portfolio like I hold, so it’s mildly conservative in that it assumes the future will be no better or only slightly worse than the past (a period which includes 2 World Wars, The Great Depression, many smaller recessions, and several “flash crashes” but still produced great returns for equity investors).

Based on that assumption, I went ahead and tabulated some data points for the 5% real returns curve to use as a quick reference guide. Like I said, these are the numbers that I’ve concluded are the best to use for projections:

**So how do you calculate your savings rate?**

Now that you’ve seen how a high savings rate enables you to reach financial independence and have the option to retire early, how do you calculate your SR to see where you fall in the table above? At first glance it may seem like an easy thing to calculate, and most people would come up with something like this:

Unfortunately, that’s wrong. There’s some mistakes in that calculation that will compound as your savings rate grows larger, making it unsuitable for people pursuing FIRE. Notice that, excluding the recent spike in personal savings rates due to the coronavirus lockdown, the average savings rate in the US has mostly been bouncing between 4 – 8% for the past several decades. Even a 20% error in such a small number doesn’t make much difference, because the average American does not save anywhere close to enough money to retire on their own without Social Security.

Because FIRE is such a niche topic with (if I had to guess) likely well under 1% of the population actively pursuing it, nobody calls out all of those articles and resources telling you how to calculate your savings rate the wrong way. So you can have a deeper understanding of the final numbers, I’m going to walk through all of the ways that I’ve seen people do the math wrong, then show why and how you can calculate your savings rate the correct way.

**Mistake #1: Not subtracting taxes from your gross income**

Once you’ve maxed out your tax-deferred accounts, there’s simply no way to pay less taxes. If we didn’t subtract out taxes from the denominator of our calculation, your savings rate would probably max out in the 65 – 80% range, depending on your personal situation and total tax burden. If you think about it, this is money that you never even had a chance to save, so my school of thought is that it’s not fair to penalize your savings rate by including it.

Another good reason not to include taxes is that I plan to pay none or very few of them in early retirement! If your annual expenses are less than $40k for a single person, or less than $80k for a married couple, you can easily pay no taxes in early retirement with little work on your part. I’ve even seen couples push it to slightly over $100k in annual expenses with no taxes paid using some more careful planning. This method is worthy of an entire article which I plan to write in the future, however the general gist is that if you have a variety of accounts with different tax treatment (tax-deferred like a 401k, tax-advantaged like a Roth IRA, and regular taxable brokerage investments) you can cleverly take withdrawals from each such that you end up with a substantial sum of money to cover your expenses with no tax bill.

Since frugality is usually a necessity to achieving financial independence, it’s probably safe to assume that most people who aspire to FIRE have annual expenses in the above ranges. Thus, removing taxes from your savings rate calculation helps standardize the comparison between your current situation and your post-early-retirement situation.

Don’t forget to subtract smaller tax line items like OASDI (Social Security) and Medicare, too!

**Mistake #2: Not properly accounting for retirement matching**

If you get matching contributions in a 401k or similar account, most people remember to add this to their savings column. However, don’t forget that your matching also counts as income! Consider the impact of accounting for this in your savings, but not your income — your savings rate would be incorrectly inflated, and have an upper bound above 100%. So make sure that you’re adding your match to both the numerator and denominator!

**Mistake #3: Overlooking some of the smaller or non-obvious savings categories**

I’ve definitely had to go back and re-crunch some of my own numbers in the past after forgetting about a small account like my HSA, which only gets $900/year deposited into it. That’s another reason to love spreadsheets though, they can easily be edited and grow over time! Here’s a list of line items that you should consider when summing up your savings:

- Net inflows to retirement accounts (401k, 403b, 457b, IRA, etc.)
- Employer matching contributions to retirement accounts
- Net cash flow into a savings account
- Net inflows into a taxable brokerage account
- Contributions to a Health Savings Account or similar
- Contributions to a workplace pension plan, as long as those contributions belong to you and can be claimed upon separation

This section likely isn’t an exhaustive list and you may very well have an additional savings category not listed, but I think that list should cover everything for 95% of people!

**Mistake #4: Handling of mortgage payments**

The portion of your mortgage payment that goes towards principal is *technically* savings in that it increases your net worth. However, homes are an illiquid asset and cannot be drawn down to pay for living expenses like you can do with your invested retirement portfolio. For that reason and for the purposes of determining your working years until FIRE, I would exclude principal paydown of your base mortgage payment from your savings rate calculation.

However, if you make extra payments towards your mortgage to pay it off faster, I think it’s fair to include these in your SR. The reasoning being that you can choose to stop making these additional payments at any time and re-deploy that cash into your investment portfolio going forward.

Home ownership can add another layer of complications to your FIRE calculations. If you pay your home off early, you’ve permanently reduced your living expenses for the rest of your life — and thus reduced the required size of your FIRE portfolio! So the recommended guidelines above aren’t a catch-all for everyone, but rather what I believe are the best methods for those newly initiated into the FIRE movement to get the most accurate estimation of their potential early retirement date.

**The best way to calculate your savings rate**

Now that we’ve examined all of the big mistakes that you can make when calculating your savings rate and how to avoid them, we’re left with the following formula:

I firmly believe that this is the best and most accurate way for the majority of people pursuing FIRE to calculate their SR.

**An example, using Jake’s real numbers**

What better way to learn than by following along with a detailed example? And keeping with the blog’s policy of as much financial transparency as possible, I’m going to be using my real financial data for this calculation. Since I recently did my budget review for the first half of 2020, I’ve already got plenty of data gathered from that 6 month time period, so I’m going to go ahead and use that. You can use any time period you’d like, but be careful to adjust your line items appropriately to your chosen time scale.

Since the earliest days when I began pursuing FIRE, my targeted savings rate has always been a 50% SR to support my goal of retiring by age 40. Full disclosure, I actually haven’t re-calculated my savings rate in at least a year, so while I have a general idea around where it’ll be, I’ll be finding out the true updated number as I write this article. Last time I checked it was around 55%, but since then I’ve reduced my 401k contribution in order to stack up cash for a down payment on a home.

Anyway, let’s start gathering the data we need, starting with my total savings amount:

Nothing groundbreaking here; these are the same numbers from my recent budget review. I did split my 401k line item into two rows to differentiate between contributions and matching. On to figuring out taxes:

A quick tip here, if you’re using tax data from your pay stub, your savings rate calculation will be easiest if you’ve adjusted your withholding amounts on your Form W-4 such that your end of year tax liability is as close to zero as possible (that is, you neither owe money nor expect a refund). Unfortunately, I didn’t remember to do this when switching jobs late last year so I ended up getting a refund. Let’s look at my total income:

Here we’ll see the flip side consideration of that tax scenario I was just talking about, where my tax refund has to be counted as income because it’s one of the cash inflows that I counted as savings earlier. It doesn’t *really* make a difference as long as you’re accurate with your accounting and your situations are similar from year to year. To elaborate, adjusting your withholding would remove this amount from both the income and taxes variables but not your savings, making the net effect zero.

That’s also where the “be careful to adjust your line items appropriately to your chosen time scale” advice comes in. A tax refund is an annual event, whereas I’m working with a 6 month time frame here. In my case it only makes half a percent of difference either way; I already counted the full refund in my savings amount from my budget review a couple weeks earlier, so I’m going to proceed as is and just round down my final SR to compensate.

**The sanity check**

If you’ve done everything right, your savings, taxes, and expenses should sum up to your total income. Otherwise you’ve likely forgotten or double-counted something. From my recent budget review we had average monthly expenses of $2677.86 over this six month period, for a total of $16,067.16 in expenses.

Now add to that my taxes and total savings from the tables above, and we end up with $48,867.31. That’s pretty darn close to my total income of $48,933.04! Only $65.73 went “missing” in my finances over the first 6 months of the year, a 0.13% tracking error. If you’re off by around 1% or higher, you probably want to go back and try to look for mistakes.

**My savings rate revealed!**

Now that I’ve got high confidence in the accuracy of my numbers, let’s plug them back into our better savings rate calculation method:

The result, 0.578 or 57.8%! If I choose not to include my stimulus check in the calculation (in case anybody claims this is unfair), the result is 56.4%. Also accounting for the half a percent error or so due to the tax refund situation described a few paragraphs above, I’m going to round to a nice, clean integer value and say **my savings rate is 56%!**

Going back to my fancy graph and table to compare savings rates to expected working years, we can see that at a 5% real return, someone starting from $0 today would on average only need to work for a little over 14 years at my current savings rate before hitting financial independence! Of course, since I’m not starting from zero (I’ve already built a net worth of over $150,000 at 26 years old), we can infer that I will likely reach FIRE before my goal of age 40.

**Really, you can do it too**

The above math is great news for tens of millions of people, because if I can make huge progress towards financial independence, then you can too. The reason I say that is because while I do make a good income, I’ve still never made 6 figures. 20% of individuals in America earn more than I do.

Additionally, I live a very comfortable upper middle class lifestyle even with budgeted spending of under $34k per year. While I’m always seeking out ways to spend less, *and* spend smarter which is one of the main goals of this blog, it’s proof that you don’t need to make a ton of money to start saving. Any income above that $34k per year (plus taxes) for me is pure savings. Even if my income was halved tomorrow — putting me around the 50th percentile for individual income in America — I guarantee that I could easily slash my spending to maintain at least a 35% savings rate.

One final tip, something I found hugely motivating in the beginning of my journey was figuring out how getting my budget into shape would affect my savings rate. I’d do the math and figure out that things like paying off a student loan would increase my SR by 3%, or how cutting my spending in an unnecessary category would get me another 2% boost. The point is, Rome wasn’t built in a day. I started around a 30% savings rate and have progressed my way up to today’s 56% SR. Nearly a decade after being introduced to the FIRE movement, I’m *still* learning new things and *still* tweaking my plans.

FIRE is a radical concept to the uninitiated, but the math doesn’t lie… in fact, it shows just how possible it is! What’s your savings rate, and how early will it let you retire?