Ask AI Coach

Calculating your savings rate is a nuanced process, especially for someone pursuing Financial Independence (FI). There’s no single “correct” way to do it—it depends on what you want to measure and how you define “savings.” Here’s a breakdown of methodologies and considerations to help you decide:

---

Core Components of Savings Rate

1. Gross vs. Net Income

   • Gross Income (Pre-Tax): Includes salary, bonuses, and all pre-tax benefits (e.g., 401(k), HSA contributions). This provides a more comprehensive view of savings relative to your total earnings.
   • Net Income (Post-Tax): Focuses on after-tax dollars, but it excludes pre-tax contributions like 401(k) or HSA, which might understate your actual savings effort.

Recommendation: Use gross income as your base for consistency across pre- and post-tax savings.

1. What Counts as Savings?

   • Include:
     • Retirement accounts (401(k), HSA, IRA)
     • Post-tax investment contributions (e.g., taxable brokerage accounts)
     • Sinking funds (car, vacation, house)
   • Exclude:
     • Money spent from sinking funds, since it's not retained wealth.
     • Any savings “used” for planned expenses during the year.

2. Handling Sinking Funds If you’re actively saving into these accounts, count the contributions as part of your savings rate but exclude withdrawals. This aligns with the concept that savings are for future financial stability, not immediate consumption.

---

Step-by-Step Calculation Example

Let’s walk through a method to calculate your savings rate:

1. Determine Total Savings Add together all contributions made to:

   • 401(k) (include any employer match)
   • HSA
   • IRA
   • Sinking funds (e.g., vacation, house, car)
   • Taxable brokerage accounts
   • Other cash savings or investments

Subtract any planned withdrawals from sinking funds for major expenses.

Example:

• 401(k) contribution: $19,500 (employee) + $6,500 (match) = $26,000
• HSA contribution: $3,850
• Brokerage account: $10,000
• Sinking funds: $5,000 contributed, $2,000 spent = $3,000 net savings
• Total savings: $26,000 + $3,850 + $10,000 + $3,000 = $42,850

1. Determine Income

   • Use gross income for consistency.
   • Include salary, bonuses, freelance/beer money, etc.

Example:

• Salary: $100,000
• Bonus: $10,000
• Freelance income: $5,000
• Total income: $115,000

1. Calculate Savings Rate Divide total savings by gross income:

Savings Rate=Total SavingsGross Income×100\text{Savings Rate} = \frac{\text{Total Savings}}{\text{Gross Income}} \times 100Savings Rate=Gross IncomeTotal Savings​×100

Example:

Savings Rate=42,850115,000×100=37.3%\text{Savings Rate} = \frac{42,850}{115,000} \times 100 = 37.3\%Savings Rate=115,00042,850​×100=37.3%

---

Tracking Year-over-Year (YoY)

To compare YoY, keep consistent definitions. For example:

• Always calculate based on gross income.
• Separate contributions into categories (pre-tax, post-tax, sinking funds) for a detailed breakdown.
• Add “used sinking funds” as a separate line item to track planned spending versus retained savings.

---

Other Considerations

1. Why Gross Salary is Best for FI Comparisons Using gross income ensures your savings rate reflects your true ability to save, regardless of tax treatment or employer benefits. It’s also a standard in the FI community.

2. Treat Pre-Tax and Post-Tax Equally While pre-tax dollars grow tax-deferred, they’re still part of your future savings, so it makes sense to count them. For FI, focus on total dollars being set aside, regardless of tax status.

3. Track Net Worth Growth In addition to savings rate, monitor how your total net worth changes YoY. This will capture investment growth and reflect actual progress toward FI.