Why your savings rate matters

Adjusting your savings rate is one of the most critical tools for achieving financial freedom. In this article, I’m going to go through what the savings rate is, and why it matters.

What is saving?

Saving is all money you do not spend.

You often hear people talk about how much they are saving, or that they are putting away to save. This makes saving sound like an active activity. But actually saving is entirely passive. It is an output. Saving is whatever is left after you have spent.

Whether you then choose to put the money you have “saved” into a savings account, or invest it, or hide it under your bed, is kind of irrelevant. If it hasn’t been spent, it is saved.

There’s an easy way to test if you are saving. If your net assets increase following a cash inflow – you are saving. On this basis, even paying off a credit card debt is a form of saving!

How to calculate your savings rate?

savings rate optimisation

Your savings rate percentage is calculated as the amount you save divided by your gross income.

Here’s an example of how you would calculate your own gross income. If you earn gross £50,000 and you spend £40,000, your savings are £10,000.  Take your savings and divide by your gross income, £10,000 divided by £50,000, and you have your savings rate of 20%.

As a formula, it is:

An alternative way to calculate saving rate

There is an alternative to look at savings rate that you also find useful. This method is calculated as gross income minus expenses divided by gross income.


Savings are the difference between your gross income and your expenses. You can think of gross income as all the money that is paid or owed to you, and your expenses are all the money you pay out and owe. Whatever remains after your expenses, is your savings.

Key properties of the savings rate

The savings rate is a function of two variables – income and expense. Changing either the amount of income you earn or the about of expenses you spend, with change your savings rate.

If your income increases, but your expenses stay the same, your savings rate will increase.

If your expenses decreases, but your income stays the same, your savings rate will increase.

So, as far as the savings rate is concerned. Increase income is good news. Decrease expenses is good news.

Savings rate is negatively correlated to the number of years to become financially independent. 

This simply means that the more you save, the faster you will become financially independent. 

Do you calculate savings rate on a monthly or yearly basis?

Ideally, calculate your savings rate for the past year.

By using a year, you will have 12 months of data. The more data to have the better. Also, people tend to know their gross annual salary, and are less clear on their monthly salary. You know you get paid £50,000 a year, but would need a calculator to check what that was monthly. 

Remember, in your bank account with only see your net income after tax and other deductions, so don’t use the money paid into your bank to calculate your savings rate. You would get wildly different answer compared to using your gross income.

If your monthly spending and income consistent month after month, you could simply look at previous month and use that to calculate your current save rate.

How to calculate your personal savings rate.

Above, we have covered off the formula for savings rate. To calculate your own savings mate, I need to know your gross income, and either save each month or the amount you spend each month.

When you’re starting out, there is absolutely nothing wrong with being in order to get a rough estimate of your savings rate. This is because, when it comes to financial independence, there is a big difference between 20% and an 80% save rate, but only a very small difference between 20% and 21%.

Don’t let perfection be the enemy of the good.

So, if you know your paid about £50,000 a year before tax, and you know you are putting roughly £200 a month into a savings account, do the quick maths – £200 times 12 months divided by £50,000 equals the savings rate of 4.8%. Let’s call it 5%.

Common questions around calculating your savings rate.

For a simple person, who has a job as their only source of income, and straight-forward expenses, calculating the savings rate is relatively straightforward.  However, there are a number of nuances that could trip you up.

Gross Income

Gross Income is all the money earned by you in exchange for your labour. It’s sometimes called salary, wages etc. 

What to include in gross income:

  • Basic pay from your employer, before deductions.
  • Bonus payments
  • Car allowance payment
  • Pension matching by your employer

This is the full payment your employer makes to you, before deductions for tax, national insurance, pension contributions, student loan payment etc. You gross income does NOT how much money you receive in your bank account for a month’s work. That is your net income, and a topic for a different day.

There are several types of deductions that may reduce your gross salary – some are great news (e.g. Pension contributions) because they increase your Invested Assets, some are ok news (e.g. Student Loan repayments) because they decrease you Debts or compensation for expenses you’ve incurred on your companies behalf. 

Some are bad news (e.g. Income tax) because these are a pure expense that does not improve your Invested Net Asset position. 

What NOT to include or deduct to calculate gross income:

  • Expenses that may be deducted from your gross income
    • Income Tax deductions
    • National Insurance deductions
    • Charitable giving
  • Savings that may be deducted from your gross income
    • Pension payments from your salary
    • Share save or stock ownership schemes
  • Debt repayments that may be deducted from your salary
    • Student loan payments
    • Cycle to Work scheme payments
  • Amounts owed to you for costs incurred
    • Compensation for company expenses

How are countries doing at their savings rate?

In the US, Statitsa reports average post-tax savings rate hovering around 8%. After tax, the average American saves less than 10% of the money that lands in their bank account.  

Note, this is a post -tax income. A better measure for financial freedom is pre-tax income. The OECD reports the average American is paying around 30% of their income in tax. So I estimate, the average American pre-tax savings rate is a mere 5-6%.

If a person saves 5% of their gross salary each year, assuming a 4% real return, it would take 475 years to reach financial independence. Unless there’s a secret to eternal youth I’ve not read about, that means the average American will never be financially free. At least, not until after they reach state retirement.

The UK paints a similar picture. British people average 8% savings rate each year, after tax. That’s according to the IFS. A strikingly similar picture to the USA. This means British people are only saving around 5% of their gross income.

Wait! Both countries, very different circumstances, but people are saving the same amount. This trend is consistent across the western world. The OECD found consistently that households save between 8% and 10% of their post-tax income. This means the average household is only saving 5%-7% of their gross income.

This extract of savings rates across countries illustrates that almost no countries are saving above 10%.

*Values expressed as a percentage

New Zealand0.450.09-1.45-1.27-2.79-3.18-2.54-2.05
United States7.635.005.676.084.873.383.724.65
Euro area (16 countries)

What countries save more than 10%?

Sweden, Luxembourg and Switzerland consistently buck the trend on savings rate. The table below illustrates this. Interestingly, these countries are all famously high cost of living and also high standard of living and score high on happiness. Is there a pattern emerging here?

*Values expressed as a percentage


Lessons from examining global savings rates.

The data is clear. Average people are do not save a high percentage of their income. And, this means that average people are unlikely to ever achieve financial freedom.

This is not necessarily a problem. These people and household may be content with spending their income.

Another subtle finding here is the consistency of rates globally. Most people and households save less than 10% of their income. Within the western world at least, it doesn’t seem to matter what country your born to or what the government policies are in that country. People tend towards a low savings rate.

There are two clear lessons from this savings rate data:

  • Most people are not on a path to financial freedom.
  • To achieve a high savings rate, you cannot behave like an average person.

What is the relationship between savings rate and financial independence?

The more money you save as percentage of gross income, the faster you will achieve financial independence. 

On face value, this probably sounds intuitively right to you. After, if you saved every penny you earned, you would have a lot of money saved!

Well, we can go a little bit deeper…

First, it’s important to clarify that saving a lot of money does not necessarily lead to financial freedom. Yes, you would have high net asset position if you save a lot. But if you also spend a lot, or if your savings do not yield a high return, you will not reach financial freedom.

Financial freedom requires you to be able to live off the return from your assets. So if you save a lot, but also spend a lot, on the day you stopped earning, you may not have enough saved to draw down upon forever. Equally, you may have “enough” savings, but have them poorly invested. In this situation, the growth in your asset value would not be enough to fund your lifestyle.

Savings rate has some special properties for determining the time it will take you to reach financial freedom.

  • A low savings rate mean you will never reach financial independence.
  • The higher your savings rate, the quicker you will reach financial independence.
  • At a low saving rate, every additional $ you save has a disproportionately high improvement in your time to reach financial independence.
  • At a high savings rate, every additional $ you save has a disproportionately low improvement in your time to reach financial independence.

In other words, there are diminishing returns to how quickly you reach financial independence the more you increase your savings rate.

The chart below illustrates these effects:

Follow the path of the blue line. First, it’s clear that the higher your save rate, the fewer years to reach financial independence. At a 20% savings rate, it would take about 40 years to reach financial independence. (41 years to be exact). At an 75% savings rate, it takes just 7 years to reach financial independence.

But the curve is not a straight line. It is steepest at low savings rates. This means relatively small increases in the savings rate will lead to bigger reduction in the years to reach financial independence.

So, whilst it takes 40 years at a 20% savings rate, it takes only 35 years at 25% savings rate. Compare that to 75%. If it takes 7 years to reach financial independence at an 80% savings rate, increasing another 5% to 80%, only reduce the years to 6 years. That’s a 1 years improvement, compared to 6 years at lower save rates.

Lessons from the save rate curve:

  • Increasing your save rate ALWAYS reduces the year until financial independence.
  • The lower your current savings rate the GREATER the reduction in the years until financial independence.

Why is the savings rate curve this shape?

Here’s a few extreme examples, that help to explain the properties of the savings rate curve.

  1. First, and most obvious, if you have a savings rate of zero percent, you will never reach financial independence. In fact, it would take an infinite number of years to be financially free. You are living hand to mouth anyway, so financial freedom is likely far from your mind.
  2. If you have a 100% savings rate, then by definition you are financially free. A 100% savings rate means you are spending none of your gross income. If you can live, without spending any of your gross income, you are financially free. That sounds a little strange, at first. We all know that expenditure is a certainly in life. Either you have become a monk, or you have another source of income paying your expenditure.
  3. At a very high savings rate, you will very quickly reach financial independence. You have a virtuous circle where you spend little, so only need a low amount of investment to generate a sufficient investment return, and you save a lot which generates a lot of investment return, and this increases your savings further. But, saving more does not do much to accelerate.
  4. Let’s say Charlie earns $100,000 and has a 95% savings rate. This means Charlie only spends $5000, and saves $95,000. At the end of year one, Charlie savings that are equal to 19 years of his spending. He could live 19 years just from the money he earned in year one ignoring inflation and investment returns. If we assume a 4% real return for Charlie on his $95,000 of savings, he would earn $3,800 from his investments, for the rest of his life. Now, he only needs $1,200 more investment earning each year to reach his $5,000 annual expenses. If he earned $100,000 in year two, and again only spent $5000, he would now have enough savings to return $7,600 a year. Bingo. His investments are earning more than his expenses. He is financially free, and then some.

Key takeaways

Here are the key take-aways of savings rate:

  • Savings rate is the ratio between your savings and your income. 
  • The savings rate is negatively correlated to the years to reach financial independence.
  • The average savings rate is less than 10%.
  • At a 10%, it would take 59 years to reach financial independence. At a 50% savings rate, it would take just 18 years. 
  • The higher your savings rate, the faster you will achieve financial independence.

Key actions

Here are the key actions for you regarding savings rate:

  1. Calculate your savings rate today.
  2. Choose your target savings rate
  3. Take action to increase your savings rate.

What’s next?

You are now ready to reduce your spending.