To become financially independent, you have to track your finances. I write articles monthly on how my finances are progressing, in my Monthly Overview posts. I have also given you insight in how I analyse my finances. In both posts, the savings rate is an important measure. For 2018, I’m going to change my savings rate calculation.
How to Calculate Your Savings Rate
Calculating your savings rate is not hard to do. You look at a certain period of time, say a month or a year. Then you take your total income and all of your expenses for this period. The difference between the two is the amount you have been saving. If you divide the savings amount by your income, the result is your savings rate.
An example always helps. If your net income in a year is say, 50,000 euros and your expenses are 40,000 euros then you have saved 10,000 that year. Your savings rate is 20% (10k divided by 50k).
Everybody calculates their savings rate differently. Going by my formula above, you wouldn’t think that there would be much variation between savings rate calculations. However, different people include different income streams and costs in their calculations, which changes the results and makes comparison hard.
Traditionally, I have been calculating my savings rate by taking all my net income, and all expenses in the time period. I don’t include investment returns in my income. Also, I use the actual income and spend as it hits my bank accounts. That means that when I budget money towards a long-term expense such as holidays, I see these as savings. Then when I spend the money after a few months, I record all of this as expenses.
Obviously this system is showing the truth, but it is also unpredictable. To make the savings rate more smooth, I decided to add a second savings rate to my monthly reports.
My New Savings Rate Calculation
I will keep reporting using my existing savings rate calculation, but I will add a second one taking into consideration amounts I budgeted for future spending.
That means that in months where I budget for future expenses, the new savings rate will be lower than the traditional one. This is simply because the new calculation will consider the future spending. However, in months where I make large spending from these budget categories, the new calculation will show a higher rate than the old one, since it will not record the large transaction as a spend in the savings rate (while the old one does).
I think it’s easiest to understand using an example. Please see the table below:
|Month||Income||Spend||Budget Future Spend||Spending from Future Category||Savings Rate Old Style||Savings Rate New Style|
|April||2,500 (bonus paid out)||1,000||100||0||60%||56%|
|May||2,000||1,100||100||500 (also included in spend column)||20% (large spending recorded that was budgeted for)||40%|
As you can see, the two systems end up giving the same savings rate of 45.7%, however, during the months, they show different results. One shows the actual spending within the month, the other shows the actual spend plus the anticipated/budgeted future spend. But then in the month where this money is actually spent, it doesn’t take that into account since it’s already recorded.
In short, I think it’s fair to say the the new style savings rate calculation shows a much smoother calculation.
What to Expect from Me in the Future
In my Monthly Overview posts, I will be updating you on two savings rate calculations, that’s easy.
In my post looking forward to 2019 I promised to start showing my actual numbers of income and expenses each month. When I do, I will show and explain both savings rate number with you.
How do you calculate your savings rate?