37%, that is our family’s( family of two, both earning, no kids) cumulative saving rate for the last 5 years(April 2015 - March 2020). It was a surprise for me, primarily because I was expecting it to be more than 50%. Each time when we start our financial year, I am usually very confident that we would be able to save more than 50% of our total earnings. That has been my assumption since the time we started our life together in 2015. So when I sat down and finally decided to run the numbers, the outcome was surprising.
It is surprising also because I always believed both of us earn way beyond our needs and have our spending in control. So hitting that targeted 50% should not have been so difficult. 50% is a conservative target by the way, to be frank, I always believed even 80% is achievable. So 37% is heart-breaking.
Why does the savings rate matter?
The saving rate has a special significance, like in the above scenario, at 37%, we will have to work for 2 years to fund our current lifestyle of 1 year. A single percentage increase in saving also means a percentage decrease in spending and hence buys you a lot more free time in the future. At 50%, one year of work earns us 1 year of freedom. Obviously this is an oversimplification, as your spending without a job might be lower, your compensation might increase in the future and hence the savings ratio will automatically go up, etc.
But I have seen people either going for a very complex and accurate model of predicting their finances or just giving up tracking their finances altogether ( as it seems too tedious and not worth the effort). The savings rate is kind of a compromise between the two, it is not way too difficult to calculate but gives you a good indication of where exactly you are heading to.
So for now, this oversimplification is a good starting point.
Another reason to know your actual saving rate(not your perceived one) is, as humans it is easy for our monkey brain to align to big bold numeric goals. Even having a simple numeric goal of like say 30% without any great reasoning can help you kick start your financial planning exercise.
How did I calculate our savings rate?
The formula I used was pretty simple, (getting all those numbers in one place, was a little difficult though)
I have kept everything that does not hit our bank account outside of this equation. So provident fund and stock/stock options stay out from both numerator and denominator. Simply because it is not a discretionary income, you don’t control the investment or the income.
The amount that I have considered is the as-on-date amount. So if I had invested 20k in a mutual fund in 2015, it comes as 20k in the numerator, not the current market value. The focus is on how much you have saved rather than how much you have made.
Saving rate over the years
When I saw the cumulative figure of 37% for 5 years, my knee-jerk reaction to rationalize this by assuming we were not earning proportionally 5 years back, and hence we started off by saving less. With time as our earnings would have increased, our savings rate should have increased. Simply put, earn more to save more. So I decided to break down the numbers over the past 5 years.
| Year | Savings Rate (%) | Savings % change | Spending % change |
|---|---|---|---|
| 2015 - 16 | 33.63 | ||
| 2016 - 17 | 27.21 | 41.92 | 92.39 |
| 2017 - 18 | 27.34 | 39.58 | 38.37 |
| 2018 - 19 | 44.29 | 75.33 | - 17.03 |
| 2019 - 20 | 43.29 | 13.59 | 19.20 |
Let's break down the findings:
Surprisingly our savings rate for the first year(with all the additional costs to set up our new life, new city) was better than the next two years.
In 2016-17, we both switched our jobs for higher pay, but as you can see all our additional earnings went into our spendings. YoY spending went up by 92%. That is the year I need to analyze further and warrants another article.
There was a turnaround in 2018-19 with the Savings rate hitting the all-time high of 44% and YoY spending was down by 19%.
The bottom line is, ‘earn more to save more’ did not really work out for us in 2016-17. It might take another post to dissect 2016-17 and 2018-19. Something went horribly wrong in 2016-17 while things started to work out finally in 2018-19.
A quick disclaimer on the number 37%, for some it might be too high or for most, it might be too low, the exact number does not matter. But ensuring that the real saving rate matches your expectations is crucial. It grounds all your financial assumptions in reality and helps you make prudent financial decisions.
As a side project, I am trying to tag all of my transactions over the last 5 years. I will publish the insights(in most of the cases with actual numbers) on this blog. I hope it will inspire people to do the same with their financial data and get better hold over their finances.
Do reach out if you need any help in computing your savings rate and analyzing your saving pattern.