Savings Rate 301: Avoid These Pitfalls With Your Savings Rate

FinBase / Live / Independence / Savings Rate 301: Avoid These Pitfalls With Your Savings Rate

October 23, 2021

Now that you know about your savings rate and why it’s important, you need to know about a few cautions.

A savings rate is not a silver bullet. If assumptions regarding your savings rate are based off of an investment return higher than your actual return, or if you plan on spending more money than you do in your current savings rate calculations once you retire, it will take you longer to reach financial independence.

As a general rule, calculating your savings rate will help you understand your timeline to financial independence. However, there are some important considerations you need to take.

How Does a Savings Rate Work?

As mentioned in our previous articles, your savings rate is an important personal finance calculation because it helps you understand the impact of your savings on your retirement. As a general rule, the more you save, the sooner you will be able to retire. So the higher your savings rate today, the sooner you can reach financial independence tomorrow.

We referenced a post that generalized the amount of time it would take for someone to reach financial independence. However, it’s based the following assumptions:

Your calculations are based on a current net worth of zero
Your financial independence number is based on the 4% rule
Your expected return is 5% (adjusted for inflation) on your investments

Based on those assumptions, the impact of your savings rate on retirement would look like this:

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

Savings Rate impact on retirement (assumptions above)

The numbers generally hold up in calculations regardless of your income. The reason being that the focus is on percentages of what you’re saving vs. spending, and your spending amount is what’s used to calculate your financial independence number. For example, if you had a 50% savings rate at either a $50,000, $75,000, or $100,000 annual salary, the time it would take to hit your FI number is ~17 years. Saving 50% at each income level means saving $25,000, $37,500, and $50,000 respectively. It also means your spending at each income level is different as well (again, $25,000, $37,500, and $50,000 respectively). Multiplying each spending amount by 25 (the 4% rule) gives you an FI number of $625,000, $937,500, and $1,250,000 respectively.

Annual Income	Annual Savings	Savings Rate	Annual Expenses	FI Number (Annual Expenses / 4%)	Years to FI
$50,000	$12,500	25%	$37,500	$937,500	32
$50,000	$25,000	50%	$25,000	$625,000	17
$50,000	$37,500	75%	$12,500	$312,500	7

Savings Rate examples with a $50,000 income

Annual Income	Annual Savings	Savings Rate	Annual Expenses	FI Number (Annual Expenses / 4%)	Years to FI
$75,000	$18,750	25%	$56,250	$1,406,250	32
$75,000	$37,500	50%	$37,500	$937,500	17
$75,000	$56,250	75%	$18,750	$468,750	7

Savings Rate examples with a $75,000 income

Annual Income	Annual Savings	Savings Rate	Annual Expenses	FI Number (Annual Expenses / 4%)	Years to FI
$100,000	$25,000	25%	$75,000	$1,875,000	32
$100,000	$50,000	50%	$50,000	$1,250,000	17
$100,000	$75,000	75%	$25,000	$625,000	7

Savings Rate examples with a $100,000 income

When Doesn’t a Savings Rate Work?

A savings rate is not a silver bullet. Remember that the assumptions made for the previous calculations are as follows:

Your calculations are based on a current net worth of zero

Your financial independence number is based on the 4% rule

Your expected return is 5% (adjusted for inflation) on your investments

Changing these assumptions may change the numbers, and you may need to adjust your timeline to financial independence accordingly.

If You Don’t Get a 5% Annual Return on Investment

When it comes to investing strategies, long-term investing in low-cost index funds is the premise behind funding your financial independence. Expecting a reliable historical rate of return allows you to make these kinds of calculations. However, if your savings are tucked away under your bed, or your expected rate of return after inflation is less, it will take you longer to reach financial independence. For example, if you have a salary of $50,000 and a savings rate of 25%, but didn’t invest your money, it would take you 75 years to reach financial independence instead of 32. And if your investments were only providing a 3% return, it would take you 40 years to reach financial independence.

Year	Savings	Contributions	Growth	Year End Balance
1	$0	$12,500	0	$12,500
2	$12,500	$12,500	0	$25,000
3	$25,000	$12,500	0	$37,500
4	$37,500	$12,500	0	$50,000
5	$50,000	$12,500	0	$62,500
6	$62,500	$12,500	0	$75,000
7	$75,000	$12,500	0	$87,500
8	$87,500	$12,500	0	$100,000
9	$100,000	$12,500	0	$112,500
10	$112,500	$12,500	0	$125,000
11	$125,000	$12,500	0	$137,500
12	$137,500	$12,500	0	$150,000
13	$150,000	$12,500	0	$162,500
14	$162,500	$12,500	0	$175,000
15	$175,000	$12,500	0	$187,500
16	$187,500	$12,500	0	$200,000
17	$200,000	$12,500	0	$212,500
18	$212,500	$12,500	0	$225,000
19	$225,000	$12,500	0	$237,500
20	$237,500	$12,500	0	$250,000
21	$250,000	$12,500	0	$262,500
22	$262,500	$12,500	0	$275,000
23	$275,000	$12,500	0	$287,500
24	$287,500	$12,500	0	$300,000
25	$300,000	$12,500	0	$312,500
26	$312,500	$12,500	0	$325,000
27	$325,000	$12,500	0	$337,500
28	$337,500	$12,500	0	$350,000
29	$350,000	$12,500	0	$362,500
30	$362,500	$12,500	0	$375,000
31	$375,000	$12,500	0	$387,500
32	$387,500	$12,500	0	$400,000
33	$400,000	$12,500	0	$412,500
34	$412,500	$12,500	0	$425,000
35	$425,000	$12,500	0	$437,500
36	$437,500	$12,500	0	$450,000
37	$450,000	$12,500	0	$462,500
38	$462,500	$12,500	0	$475,000
39	$475,000	$12,500	0	$487,500
40	$487,500	$12,500	0	$500,000
41	$500,000	$12,500	0	$512,500
42	$512,500	$12,500	0	$525,000
43	$525,000	$12,500	0	$537,500
44	$537,500	$12,500	0	$550,000
45	$550,000	$12,500	0	$562,500
46	$562,500	$12,500	0	$575,000
47	$575,000	$12,500	0	$587,500
48	$587,500	$12,500	0	$600,000
49	$600,000	$12,500	0	$612,500
50	$612,500	$12,500	0	$625,000
51	$625,000	$12,500	0	$637,500
52	$637,500	$12,500	0	$650,000
53	$650,000	$12,500	0	$662,500
54	$662,500	$12,500	0	$675,000
55	$675,000	$12,500	0	$687,500
56	$687,500	$12,500	0	$700,000
57	$700,000	$12,500	0	$712,500
58	$712,500	$12,500	0	$725,000
59	$725,000	$12,500	0	$737,500
60	$737,500	$12,500	0	$750,000
61	$750,000	$12,500	0	$762,500
62	$762,500	$12,500	0	$775,000
63	$775,000	$12,500	0	$787,500
64	$787,500	$12,500	0	$800,000
65	$800,000	$12,500	0	$812,500
66	$812,500	$12,500	0	$825,000
67	$825,000	$12,500	0	$837,500
68	$837,500	$12,500	0	$850,000
69	$850,000	$12,500	0	$862,500
70	$862,500	$12,500	0	$875,000
71	$875,000	$12,500	0	$887,500
72	$887,500	$12,500	0	$900,000
73	$900,000	$12,500	0	$912,500
74	$912,500	$12,500	0	$925,000
75	$925,000	$12,500	0	$937,500

25% Savings Rate with no return on investment

Year	Savings	Contributions	Growth	Year End Balance
1	$0	$12,500	3%	$12,875
2	$12,875	$12,500	3%	$26,136
3	$26,136	$12,500	3%	$39,795
4	$39,795	$12,500	3%	$53,864
5	$53,864	$12,500	3%	$68,355
6	$68,355	$12,500	3%	$83,281
7	$83,281	$12,500	3%	$98,654
8	$98,654	$12,500	3%	$114,489
9	$114,489	$12,500	3%	$130,798
10	$130,798	$12,500	3%	$147,597
11	$147,597	$12,500	3%	$164,900
12	$164,900	$12,500	3%	$182,722
13	$182,722	$12,500	3%	$201,079
14	$201,079	$12,500	3%	$219,986
15	$219,986	$12,500	3%	$239,461
16	$239,461	$12,500	3%	$259,520
17	$259,520	$12,500	3%	$280,180
18	$280,180	$12,500	3%	$301,461
19	$301,461	$12,500	3%	$323,380
20	$323,380	$12,500	3%	$345,956
21	$345,956	$12,500	3%	$369,210
22	$369,210	$12,500	3%	$393,161
23	$393,161	$12,500	3%	$417,831
24	$417,831	$12,500	3%	$443,241
25	$443,241	$12,500	3%	$469,413
26	$469,413	$12,500	3%	$496,370
27	$496,370	$12,500	3%	$524,137
28	$524,137	$12,500	3%	$552,736
29	$552,736	$12,500	3%	$582,193
30	$582,193	$12,500	3%	$612,533
31	$612,533	$12,500	3%	$643,784
32	$643,784	$12,500	3%	$675,973
33	$675,973	$12,500	3%	$709,127
34	$709,127	$12,500	3%	$743,276
35	$743,276	$12,500	3%	$778,449
36	$778,449	$12,500	3%	$814,678
37	$814,678	$12,500	3%	$851,993
38	$851,993	$12,500	3%	$890,428
39	$890,428	$12,500	3%	$930,016
40	$930,016	$12,500	3%	$970,791

Savings Rate with 3% return on investment

Year	Savings	Contributions	Growth	Year End Balance
1	$0	$12,500	5%	$13,125
2	$13,125	$12,500	5%	$26,906
3	$26,906	$12,500	5%	$41,377
4	$41,377	$12,500	5%	$56,570
5	$56,570	$12,500	5%	$72,524
6	$72,524	$12,500	5%	$89,275
7	$89,275	$12,500	5%	$106,864
8	$106,864	$12,500	5%	$125,332
9	$125,332	$12,500	5%	$144,724
10	$144,724	$12,500	5%	$165,085
11	$165,085	$12,500	5%	$186,464
12	$186,464	$12,500	5%	$208,912
13	$208,912	$12,500	5%	$232,483
14	$232,483	$12,500	5%	$257,232
15	$257,232	$12,500	5%	$283,219
16	$283,219	$12,500	5%	$310,505
17	$310,505	$12,500	5%	$339,155
18	$339,155	$12,500	5%	$369,238
19	$369,238	$12,500	5%	$400,824
20	$400,824	$12,500	5%	$433,991
21	$433,991	$12,500	5%	$468,815
22	$468,815	$12,500	5%	$505,381
23	$505,381	$12,500	5%	$543,775
24	$543,775	$12,500	5%	$584,089
25	$584,089	$12,500	5%	$626,418
26	$626,418	$12,500	5%	$670,864
27	$670,864	$12,500	5%	$717,532
28	$717,532	$12,500	5%	$766,534
29	$766,534	$12,500	5%	$817,986
30	$817,986	$12,500	5%	$872,010
31	$872,010	$12,500	5%	$928,735
32	$928,735	$12,500	5%	$988,297

Savings Rate with 5% return on investment

The main point to remember is that in order to make savings rate calculations work for you, you’ll need to invest your savings. Investing them in low-cost index funds that have low fees and keep pace with the market over the long term will help ensure your savings rate calculations correctly chart your path to financial independence (and avoid the embarrassing conversation that it took you 30+ more years to reach your goal because you didn’t begin investing sooner).

If You End Up Spending More in Retirement

The other caution is to avoid lifestyle inflation. When the time comes to retire and you can step away from work, what are you going to do with your time? If your newly found freedom hours cost more money than they did before, you’re going to run out of money a lot quicker than the 4% rule allows cushion for. Your financial independence number is based on the 4% rule, which equates to 25x your annual expenses. If you spend $50,000 annually, your financial independence number is $1,250,000. This would allow you to safely live off of 4% of your investments through retirement (or, spending $50,000 each year). But if you decide to retire and then ramp up your spending to $75,000 (6%), you’re spending money faster than it can compound. To be safe, you may want to save a little more ($75,000 x 25 = $1,875,000) in order to give yourself the cushion you may need to avoid your investments running out.

By using the 4% rule as a rule of thumb when planning for retirement, you can back into the amount you should look to save.

Annual Expenses	Withdrawal Rate	Financial Independence Number
$50,000	4%	$1,250,000
$75,000	4%	$1,875,000
$100,000	4%	$2,500,000
$150,000	4%	$3,750,000

Utilize the 4% rule when considering your expenses in retirement, and save accordingly

Summary

While savings rates can be very helpful, it’s important to remember the assumptions your savings rate are made on. It wouldn’t be wise to blanket target a number of years for financial independence based on a savings rate that you didn’t understand. Do your calculations, and make sure to invest properly. Doing so will get you to the top of your financial mountain.