How to Calculate Your Savings Rate!
On top of earning extra to fully Escape the Rat Race you need to invest your money so that you can build up a pot of money you can live off, this is why you need to know how to calculate your savings rate.
Therefore this post is going to go down a slightly different path to the usual posts and instead focus on how much money you will need to retire early and how long it will take you.
To do this you need to know how to calculate your savings rate.
How Do You Calculate Your Savings Rate?
((Total Income - Expenditure) / Total Income ) * 100 = Savings Rate
Using some figures...
((£2000 - £1000) / £2000 ) * 100 = 50%
Using our example above, the savings rate would be 50%.
Why is the calculation important and what would a savings rate of 50% mean?
Well quite simply, a savings rate of 50% would mean you could retire in 15-20 years!
What if your savings rate is only 30%, well unfortunately you're going to have to work another 25-30 years... (if this seem like too long to work, you can always increase your income - check out our how to make £1000 a month guide)
So what is the maths behind this?
Well the aim is to have enough money in your pot to be able to withdraw 4% plus inflation per year. Therefore you need to have enough money in your retirment pot so that 4% is equal to a years expenditure.
Therefore 25 times your current expenditure is equal to the amount that you need to within your retirement pot to enable you to retire with enough in savings to last your retirment.
In our example £1000 a month would be £12,000 a year, this would therefore require a retirement pot of £300,000.
To save £300,000 you would need to save £12,000 a year for a maximum of 25 years, with good investment returns this time could greatly reduce.
For reference to the 4% per year comes from the Trinity Study:
It states that a person has sufficient savings in assets if 4% of his/her assets are sufficient to cover a year's expenses. In the original study success was primarily judged by whether portfolio lasted for the desired payout period, i.e., the investor did not run out of money during their retirement years before passing away; capital preservation was not a primary goal, but the "terminal value" of portfolios was considered for those investors who may wish to leave bequests.
So how does calculating your savings rate get you a timescale on how long it takes to get to your retirment age?
In basic terms the more of your current income you spend each month, the less you will be putting into your pot to retire.
Therefore the higher you can get the percentage the quicker you can reach financial freedom and look to jet off into the sunset.
Lets follow the recommended wisdom of saving 15% of your income:
£2000 a month income
With expenditure of £1,700 a month.
((£2000 - £1700) / £2000) * 100 = 15% savings rate
£1700 a month is equal to £20,400 a year.
£20,400 times 25 equals £510,000.
Therefore to retire on the 4% rule you would need £510,000 in your retirement pot.
To save £510,000 from £300 a month, assuming a 4% interest rate, would take 48 years.
So this leaves you with an option, either lower your expenditure or increase your income.
Although I have not written any guides on lowering expenditure yet, I have written on how to increase your monthly income so lets use that and assume you are making the extra £1000 a month but have no increased your expenditure.
£2000 + the extra £1000 a month income = £3000.
((£3000 - £1700) / £3000) * 100 = 44% Savings rate
Retirement pot is still £510,000
Again assuming a 4% interest rate, by saving £1300 a month.
You could reach your goal in 21 years + 1 month.
Just to finally show how cutting down on your expenditure and doing some simple things to save £500 on your current expenditure, the maths would look like
£2000 + £1000 extra a month
£1200 monthly expenditure
((£3000 - £1200) / £3000) * 100 = 60%
£1200 a month is equal to £14,400 a year
£14,400 a year times 25 equals £360,000
£1800 a month into savings again with a 4% interest rate.
Would mean you could retire in 12 years and 11 months.
Hopefully this gives a brief introduction into why investing your money is so important, why calculating your savings rate is important and also why increasing your income whilst decreasing your expenditure could give you the financial freedom you want.