The “effective savings rate” is a key metric for anyone planning or executing a plan for early retirement. Before starting down the path of early retirement, for example, many folks will first consider “How much am I currently saving?” and “What trade-offs might I have to make in my daily life to increase that savings rate?”
Once embarking on the path to early retirement, many people will go through phases to find ways to increase that savings rate. Some may be the super-analytical type. They’ve optimized many other aspects of their early retirement journey, and now they want to focus on optimal execution of savings, extracting every bit of value from their day job’s pay check. Some of them may also be the competitive type. They might try to put their numbers up against fellow aspiring early retirees to see who can find the best, most creative ways to maximize savings. Sometimes, retirees might find a renewed interest in maximizing savings rate because they might be seeking a sense of increased freedom in their current situation. Often, saving a bit more paycheck can be a great way to cope with a stressful time at work. Make your paycheck work harder for you, right as your company is making you work harder for them!
For any number of great reasons, savings rate is a hugely important factor, and one you should certainly visit and revisit on your path to early retirement. For these reasons, I’m going to offer some thoughts to help clarify what parts of the savings rate are and are not important for your early retirement.
What the Savings Rate is Not
The savings rate is not a number. That’s right, despite all the great articles on how to come up with all the calculations, about how to find and combine all the numbers, the essence of the savings rate has nothing to do, in fact, with numbers. Early Retirement Now has a great write-up about different ways to split your income, assume different tax rates, and come up with several different percentage splits to represent your savings rate.
Understanding different accounting methods might give you insight into whether you have a 60% or 62% savings rate. Calculating an exact number can definitely be a fun exercise to help you think about your current expenditures. It may help inspire you to find more stoic ways to score an even better number. However, calculating your exact percentage, figuring out whether to include your 401k contribution, your employer match, the income from your investments, or the asset value of your car is really not helpful for determining the more important aspects of reaching early retirement.
Instead there are much more important aspects to focus on when it comes to your savings rate.
The True Essence of the Savings Rate
The true importance of the savings rate is in how fast you can build up your retirement passive income. The true importance in savings rate is not the percentage of how much you save, it’s how many dollars you actually save. The real importance of boosting your savings rate is boosting your savings (and income).
Here’s an example why savings is really the important number. Say you’ve run all your retirement plans, and you know that you can retire as soon as you hit $1.5million. If you currently still need to save $1million more dollars, focus on maximizing the number of dollars you can save. If you know how many dollars you can save in a year, you know how big a chunk of that remaining balance you can save every year. You also know exactly how many years you have left to
work save, before you can retire.
Saving for my own Retirement
The Mustache-father wrote a famous article on the surprisingly simple math behind early retirement*. However, that entire chain of logic hinges on keeping out of pocket spending perfectly flat from working days into retirement. If you think your spending will stay perfectly flat, consider (among a multitude of other examples) the total cost and benefit of your employer medical plan.
In my case, my employer subsidizes my premium over $7k per year (in addition to my own $200 out of pocket per month). Thanks to a large, healthy corporate risk pool, I receive better coverage in the form lower annual premiums and lower out-of-pocket maximums. Despite all the baffling goings-on at my job, this health insurance is actually a great deal. If I retire and purchase Obamacare, I will lose corporate subsidies and join a much more expensive risk pool.
Any savings realistic savings rate calculation should include the subsidy (as both a part of my income and also a part of my expenses), but the savings rate is not the important part. Instead, I should determine my true absolute retirement spend, determine a safe withdrawal rate, and determine how much more I need to save to get there. This honest accounting may mean saving a more, but it also means less surprises when I get to retirement.