You want to know our savings rate? Which one?

Last week, I read a nice post on Chief Mom Officer on the challenges of calculating savings rates. Right around that time I was also revisiting our 2017 budget and the projections of how much we are going to save this year. This is the last full calendar year before our planned retirement in early 2018 and it’s imperative that we stay on track and keep a high savings rate on the home stretch. But how high is our savings rate? Is there even a generally accepted way of calculating a savings rate? What are some of the pitfalls? We were surprised about how easy it is to mess up a calculation as seemingly trivial as the savings rate.

So, here’s our situation: We group our annual compensation into six major categories:

Net Income vs. Gross Income vs. Total Compensation. Not to scale!

Side note: we plan our tax withholding so that we come within a few hundred dollars of our actual tax bill. If we were to expect a large tax refund or large tax bill in April we would certainly incorporate that number in the tax component T. 

How should we calculate our savings rate? Here are a few principles about what we should and shouldn’t include:

What should always be included in the savings rate calculations:

  • Employer matching contributions (S1). The reason why we’re getting matching benefits for the 401k and the HSA (Health Savings Account) is not because Mr. ERN’s employer is in a charitable mood. Some smart accountants and lawyers figured out a more tax-efficient way of forking over a compensation package that XYZ Inc. deems appropriate for Mr. ERN’s hard work. Whether XYZ Inc. pays it to me and I save it or XYZ Inc. uses the money to match my savings contributions is irrelevant. Money is fungible. So, the entire amount in S1 is included in our savings (but subject to some limitations, see below).
  • Debt principal payments (in S3). For us, this is the mortgage principal paydown. From an accounting and economics point of view, there should be no discrimination between building assets and reducing liabilities. We increase our net worth and there is even a “return” on the “savings” in the form of lower future mortgage interest payments. It’s not a very generous return, but it surely beats the 10-Year Treasury yield right now! And of course, the number one reason for including the debt paydown as savings is that the reverse should be even more obvious. Going further into debt should be considered negative savings. Otherwise, lots of bankrupt folks would argue, “hey, we never had a negative savings rate, we only increased our credit card debt!” How preposterous is that? So paying down the principal of our mortgage is included in S3.

What should never be included in the savings rate:

  • Mortgage interest. We want to count our principal paydown as savings, see above, but including the interest portion is a big no-no. For us, the interest payment is essentially the equivalent of rent. We wouldn’t include rent for a house or apartment as savings and likewise, we shouldn’t include the money we pay to the bank to borrow (=”rent”) their money. Same goes for property taxes and homeowners insurance.
  • Capital income (interest, dividends, capital gains) from existing assets. This might a contentious issue, so let me explain where I’m coming from. Imagine two individuals, Anne and Ben who each earn $100 in wage income and save $50. They both have a 50% savings rate. But what if Ben has an additional $100 of capital income from retirement savings and it’s all reinvested. It’s probably a bad idea to call that a 150% savings rate. But even if we add the extra income in both the numerator and denominator we get (50+100)/(100+100)=75%. That 75% rate is an accurate estimate of some savings rate, for sure. But the question is how sensible and informative is that number? 25 of Ben’s 75% are merely a result of past savings efforts. We probably wouldn’t argue that Ben has a 50% savings rate if she consumed all of his wage income and simply reinvested his capital income: (0+100)/(100+100)=50%. If we want to measure our savings discipline and make comparisons between people who are at different stages in their retirement savings accumulation it’s best to set aside the capital income and keep that money behind a firewall! And of course, another reason why I don’t like to include capital income: It’s too volatile for equity-heavy portfolios.

Our actual income vs. savings vs. taxes vs. consumption numbers.

So, keeping those principles in mind, how much do we save? See chart below, which is a breakdown of our annual gross compensation into the six components. We won’t post our actual annual income but this is all scaled; per $100 of total compensation:

  • S1: The employer matching is not that high. That’s because more than half of Mr. ERN’s compensation is the annual bonus, which is ineligible for 401k matching. One of the disadvantages of working in finance!
  • S2: We save a bit over 17% in 401(k), HSA and a plan for voluntary deferrals. The latter is a plan that allows saving a portion of the cash bonus to defer income taxes (though not payroll taxes).
  • T: Taxes make up almost one-third of the total compensation. It’s one of the reasons we are planning an early exit from the job market. We are sick and tired of sharing one-third of our hard-earned income on average, and almost 50% at the margin. And this doesn’t even include property and sales taxes!
  • D: Deductions for the company health plan, transportation benefits, etc. are only about 1% of the total compensation.
  • S3+C: That’s our net income or take-home pay. Only less than half the total compensation. Out of that amount, we consume about 55% and save the rest in after-tax IRAs, taxable savings, mortgage principal reductions, etc.
Components of our gross compensation, per $100.

Savings Rate #1: Based on gross total compensation 41.24%

That’s the easiest savings rate to compute: Divide all the savings by the entire gross compensation:


In our case, that’s 41.24%. Not a very impressive number, but that’s an artifact of the 30%+ average tax rate. We have no illusion of ever generating a 60%+ savings rate based on gross compensation when we pay so much in taxes. It’s still a pretty decent savings performance because in the 3-way split of $100 worth of income we’ll save $41.24, pay $32.52 in taxes and consume $26.24 (actual consumption plus the deductions for healthcare and transportation, which we also consider consumption). Consumption is the lowest and savings the highest share, just like we want it!

Savings Rate #2: Based on the take-home pay (a bad, bad idea!): 90.35%

Mr. Money Mustache has a classic post to calculate the time you need to reach FIRE as a function of the savings rate. He defines the savings rate as savings “as a percentage of the take-home pay.” What is our take-home pay? I guess it’s our net paycheck, right? If we were to calculate our savings rate as total savings (all the green bars) divided by that take-home pay number we’d reach a pretty impressive number: 90.35%!


How awesome is that? Not very awesome at all because it’s an utterly meaningless number. Specifically, this 90% number is a very bad measure of how frugal we are. Believe me, we’re modestly frugal, but not that frugal because this 90% “savings rate” doesn’t imply we consume only 10% of our take-home pay. Do you notice a problem with the formula above? We count the pre-tax savings in the numerator but not in the denominator. The way we calculated the savings rate violates the simple rule that every savings rate formula should satisfy:

Mr. ERN’s Essential Rule for Constructing a Savings Rate: Any component we count in the numerator has to also show up in the denominator.

If we don’t follow this rule we could get completely non-sensical results. If we had increased our 401k contributions (after-tax, because we max out the pre-tax) and bonus deferral, we could have achieved a 100% (!!!) savings rate, how crazy is that? But simply reshuffling savings should not impact our savings rate.

So, if we’re not careful about calculating our savings rate properly we could easily delude ourselves. Strictly speaking, S3+C is our “take-home pay” but if we look up the 90% savings rate in Mr. Money Mustache’s table and conclude that it should take only under 3 years to reach FIRE we just made a major miscalculation. The 90% savings rate we calculate here doesn’t imply we consume only 10% of our take-home pay. In fact, we consume more than half: 24.97/(24.97+20.68)=55%. Taking the term “take-home pay” in MMM’s post too literally and the formula for how long it takes to reach FIRE is completely wrong.

Savings Rate #3 Based on after-tax compensation: 61.11%

A more sensible approach to a savings rate based on net income is to simply eliminate the tax component from the denominator but count all of the savings components. In other words, count all savings in both numerator and denominator:


The denominator is not really our take-home pay. But this savings rate is still what we want to use in the FIRE timing calculation a la Mr. Money Mustache or our own post from long time ago. In any case, by that measure, we get to slightly above 60%. Pretty good savings discipline, I would argue, but not crazy-frugal.

Savings Rate #4 Based on after-tax total compensation, adjusting for deferred taxes: 57.65%

One little wrinkle in the calculation above: $1 worth of after-tax savings is worth more than $1 in tax-deferred savings. Physician on FIRE had a nice post on this topic. So, let’s give the various savings components a haircut to account for future tax payments:

  • 401k savings: 15%, which is our estimated marginal tax rate on 401k distributions in retirement.
  • HSA savings: no haircut! We plan to spend this money on health expenses. Tax-free!
  • Voluntary deferrals: if Mr. ERN quits in 2018, the voluntary deferrals would be paid out and taxed at our 2018 marginal tax rate. So we discount the savings by that estimated rate. Ouch!

After applying the haircut to components S1 and S2 and adding a tax component T1 in our breakdown, this is how our total compensation looks like: We just got hit by another $5.51 in taxes for a total of more than $38 per $100 earned. That’s only the average. Marginal taxes are closer to 50%. It’s really time to leave this hamster wheel and retire early!

In any case, if we remove the $5.51 in future taxes from both the numerator and denominator we get a savings rate of just under 58%. Still pretty impressive, still above 50%, but not as high as some of the extremely frugal savers in the FIRE community.

Components of our net compensation, per $100.


Calculating savings rates is a can of worms. Gross vs. net income makes a difference of 20 percentage points. Fudge the numbers by using our take-home pay instead of after-tax compensation as the denominator and we’d make the not-so-frugal ERN family look super-frugal with a (completely meaningless) 90% savings rate.

We hope you enjoyed today’s post! How do your savings rates stack up? Please share your comments below!

114 thoughts on “You want to know our savings rate? Which one?

  1. You’d think this should be obvious, right? But the confusion arises among many because of not knowing difference between what’s truly an asset and liability. This is partly fueled by media and advertising. The other day I cringed to see a car ad that said “Invest in an asset that really moves you”.

    1. ummm that isn’t wrong. A car is most definitely an asset. It is just a depreciating asset. If you sold the car you would receive money, that makes it an asset.

      1. I can see why the Ad speaks to you. Anything that depreciates does not meet my definition of Asset. With car, you have guaranteed Depreciation from the moment you drive it off the dealer lot.

        1. I can live with calling a car an asset. It’s called a durable good in this context, but that doesn’t rule out the term “asset.”
          The offensive word in the ad for me was the term “invest” because a car used as a consumption good is not an investment, by definition. It could be an investment good, say, if you invest in a fleet of Uber cars, hire drivers, and make income. The cars depreciate, they are assets and they are investments.

        2. I can live with calling a car an asset. It’s called a durable good in this context, but that doesn’t rule out the term “asset.”
          The offensive word in the ad for me was the term “invest” because a car used as a consumption good is not an investment, by definition. It could be an investment good, say, if you invest in a fleet of Uber cars, hire drivers, and make income. The cars depreciate, they are assets and they are investments.

          1. I use a simple definition ERN. An asset is something that either pays me or increases in value with time. Any ‘investment’ not meeting that definition is not an asset for me. So, car is definitely not an asset for me.

            1. Sorry for the late input; just read this fine article. My car transports me to work and thereby enables an income that, by any measure, is worth more than its expense. So it is indeed an investment, akin to a capital good.

  2. WooHoo! I calculated for myself a 46% All-in savings rate… not as bad as I thought it would be… and yet still some room for improvement.

  3. Wow, Big ERN. You never cease to amaze. Fantastic post, true “evergreen” content that can be used for years to explain the complexities of savings rates, and the impact of the different methodologies on the results. You’re a thinker, I’m impressed. Great post, on an important topic.

  4. Hahaha, this is a good point! I haven’t put much thought into how different your savings rates can be, but it’s true. Heck, savings rates between different people can vary so drastically. I think it’s time for the FIRE community to specifically define what a savings rate entails. 😉 Anyhoo, our rate was at 60% this month, which we applied directly to our student loans. Woop woop!

    1. Nice! 60% is really high, especially when not fudging the numbers as I tried in #2! Picture it as saving $1.50 for every dollar you consume! You can reach the 25 to 30x consumption necessary to retire early pretty quickly!!!

  5. Great read as usual. I think calculating a savings rate is an interesting exercise, but really isn’t a goal or something to compare to others. Like you said, there are too many variables that create ambiguity. It doesn’t directly relate to a long term goal.

    I think if it is calculated it should always be (income diverted into positive net worth) / (gross income). Even that basic definition doesn’t tell me how close I am towards anything significant.

    1. Exactly! And our calculations only scratch the surface. For business owners, for example, it’s a lot more difficult to disentangle how much money is coming from labor income, how much from investments, etc.
      Thanks for your comment!!!

      1. Which is, in my opinion exactly the reason why I believe any cashflow (no matter whether active or passive, from business, real estate, lending, dividends or royalties) should be included in the income portion. After all, with every rent, dividend or interest payment coming in I have a choice whether to consume it or re-invest it. If I do the latter, it counts towards my savings rate.

  6. Big ERN,
    Another great post!

    I long ago gave up efforts to precisely and accurately calculate our so-called “savings rate”. In addition to the issues you raise, there are plenty more that have twisted my noodle.

    We have a long tradition of saving any monetary gifts given to us. Should we include or exclude these amounts from the “savings rate”?

    What about rents from rental properties? If we use the positive cash flow to pay down the mortgage on the property, then should the extra principle payments be part of our “savings rate”? What if we invest the free cash flow in equities? Or accrue the positive cash flow to eventually purchase another rental property?

    What if we add improvements to a rental property in order to get higher rental payments (is this a cost or an asset)? What about the cost of repairs (i.e., a new roof); the cost impacts our cash flow, but if the roof has a 20-30 year life, we have deferred future expenses, so is it “fair” to “take the hit” on your “savings rate” in just one year?

    How about royalties? Does including/excluding the royalty income depend on what generates the royalties–patents, copyrights, mineral rights, or wind rights? If the royalty payments are from mineral rights (oil, gas, or other commodity), should you have a depletion allowance that nets against the actual royalty amount since the extraction that produces the royalty income will eventually deplete the resource?

    There are other examples we have run across in searching far and wide in our quest for FIRE and there are likely many more that we have never contemplated.

    It is interesting to note that most of the more complicated situations on this page generally do not matter for folks just starting out on the FIRE path. We started with nothing other than income from our jobs with almost no assets or chattel. Calculating a “savings rate” was easy and helpful for motivating us and projecting our financial path into the future. A few years into our journey, the creation and accumulation of assets and liabilities clouded the picture WRT to “savings rate” as new source of “income” developed and grew.

    When you get to the point where the ERNs are at financially (on the verge of ER), Net Worth and Desired Budget in ER are far more important numbers to know and project than chasing the chimera of calculating your “correct” savings rate.

    1. Oh, my! That’s even more of a can of worms. Once you start with rental properties or small business income or royalties it’s really hard to do keep the firewall between gross income and reinvested income from existing investments.
      Great comment!

      1. I add in miscellaneous “income”–cash back rebates such as the Costco rebate and Amazon points, Ebates checks, car insurance dividend checks, expense reimbursement from my employer and de minimis bank interest into my “income” as well as into the consumption category.

  7. Thanks for the shout out ERN-I love the way you’ve illustrated my point about savings rates! It was amazing to me how many different ways to calculate savings rate were left in the comments of my article.

  8. ERN,
    You should see if you can get Jim Collins to add an appendix to his book with your SWR articles and this. Pretty great thought process on these topics. Keep up the amazing work. Can’t get enough Big ERN in my inbox. Thanks JD

  9. Why make a simple thing complex? it is savings/income. Full stop!

    And yet, that is where all the problems start.

    Our own savings rate is based on net take home pay, corrected for tax refund we get. That is what is actually paid out to us. So, the denominator for us is net take home pay + tax refund. I do exclude dividend and options income, for the reasons you quote.

    Why ignore employer saving for our pension? In Belgium, the employer contribution to our pension is peanuts compared to the net income and tax refund. I am happy to ignore this extra income.

    Furthermore, I do count our interest payments on the mortgage as savings. And I agree, it is wrong. In a certain way, it offsets the first mistake. Why do I do this: easier as the amount taken out of our account is mortgage + Interets and both vary every month.

    So, it goes a little like this: mortgage + interest+ what goes to investment accounts/net income+ tax refunds. In your tems S3+tax refund / S3+D+C

    Why do I do that: too lazy and I do not really care what the exact number is. The system is in place, it will yield results and I do not want to focus on a number that I can change by tweaking a little here or there.

    Furthermore, we decided to live more now and travel more. Thus, our SR went down. NO big drama, big joy in our life!

    1. Here in the U.S. very few people still have pensions. I have one but the employer makes no more contributions to it. And since it’s not really money in the bank that I can see I’d ignore that too.
      Mortgage interest is probably low enough in Europe (1-2%, right?) so it might just offset the pension. Good point!
      Thanks for sharing!

  10. I do not count principle payments on non appreciating debt. For example if I have a car payment. Simply put I treat it as a yearly expense. Simply put unlike my home I don’t expect to be able to sell the car and recoup my money. Thus paying it back is the same as interest payments. Beyond that I generally measure the denominator as full stack excluding match. The numerator is s1, s2, and s3 subject to the prementioned caveat. I don’t discount for future tax rates as they are unknown. Based on that measurement we are right around fifty percent most years. In my case I’m comparing to myself year in year. So as long as I always measure the same way, and my match doesn’t change significantly, then it’s a good benchmark year on year.

    1. Ha, good point! One could do either a depreciation “expense” and do count the principal paydown or simply consider the entire car payment as the cost of running the vehicle as you do. Great point. Hadn’t thought about that!

  11. Thanks for explaining this! I’ve been scratching my head with the methods that everyone else uses to calculate savings rate at other blog sites. This one makes sense and seems the most accurate.

    Two questions did come up when I went through your post. For S3, do you include savings that don’t make its way into an investment? For instance, if the money is going to build a larger emergency fund in a low yield savings account? Including this money would throw off the estimated ‘time to retirement’ charts based on savings rate, since this money will not achieve the higher expected long-term yields of other savings invested in index funds/bonds/etc.

    Second, where would you classify 529 college savings? Would it be a consumption, since that money is essentially being spent now on your children and will likely not be used for retirement?

    Keep up the good work!

    1. Thanks!
      We don’t have a designated emergency fund:

      We consider it a deadweight for exactly the reason you mention: the “savings” would mess up the

      529 is also a touchy issue. Right now we do count it but technically speaking we shouldn’t. Either we count it, but then we should also recognize the big college expenditure shock right when we’re in retirement and our withdrawal rate would be much higher for 4 years. Or we assume a nice smooth withdrawal path, in which case we shouldn’t count the 529 as savings.

      Lots of little details to consider!!!

  12. Wow, thanks for another great post.
    I think if you delve into MMM’s original post you will find he uses and recommends formula 3.

    An interesting thing to pursue is not only savings rate but also savings rate compared to your income. Since it is easier to have a higher savings rate the higher your income is since your base needs are a much smaller portion of your net pay. I know this isn’t a competition but someone with a 40% savings rate on a $50,000 income is living more efficiently than someone saving 60% on a $200,000 salary.

    1. Agree: Implicitly, MMM has to assume you use formula 3. Otherwise the calculation doesn’t make sense. But you really have to read between the lines. Take-home pay doesn’t sound like you have to add the earnings in S1 and S2 back into denominator.
      I like the idea of adjusting the savings rate for the absolute bear-bones essentials. That would be a better measure for savings disclipline. But for the MMM calculation for how long it takes to reach FIRE it’s still formula #3, potentially #4.

  13. I really appreciate the effort you invest in effective communication. The graphics anchor the explanation and simplify what could easily be a bowl of spaghetti. I usually do not like reading posts that cover familiar ground, but you have a fresh approach here that is valuable. Thanks.

  14. I have largely abandoned the idea of the savings rate in favor of something that works better for me. I keep a spreadsheet of the amount of money going out every month and I try to make money going into investments as high a percentage of that as possible and money spent on consumption as low as possible.

    I exclude my student loan payments from either list. I am on a public service forgiveness program, so extra money spent towards the principle doesn’t actually benefit me in the long term, so it isn’t really an investment. At the same time, money spent on the loans won’t carry with me into FI, because the loans will be forgiven by then, so it doesn’t make sense to include it in consumption for retirement planning purposes either.

    I have thought about posting about this to see if the FIRE community has tweaks or can spot problems that I’m missing, but haven’t gotten around to it (and don’t know if anyone would actually be interested in reading it).

    1. That’s probably the best solution. Save a lot of money, who cares about the percentages then? 🙂
      And agree: the student loan and loan forgiveness program adds another layer of complexity and idiosyncrasy. And I thought our finances were complicated, haha!
      Thanks for sharing your experience!

  15. I use both #1 and #3 to calculate our savings rate. On my blog I only publish the after-tax savings rate which for 2016 was 50% and is projected at 51% for 2017. However, I hadn’t considered picking up the matches from my 401K and HSA contributions that I max out every year (which is about $6K in 2017). I just let those flow through to net worth.

    But I also like to calculate our gross savings rate as well, which is currently running at around 37%. I like to look at this number to see how tax inefficient we are. The goal is to eventually work this number higher by diversifying our income to more tax favored streams.

  16. The devil is in the details. I calculate net and gross savings rates, and wholeheartedly agree that any savings in the numerator must be included in the denominator. How you do manage to save money you didn’t ERN? I mean earn?


    1. Great, I knew we’d have the same approach on this one.
      And I can’t believe that after one year of personal finance blogging the ERN-earn wordplay never occurred to me. Thanks, PoF! The possibilities are endless:
      “Increase you ERNings, subscribe to our email list”
      “Read our blog and go from small earner to Big ERNer”
      I hope I don’t have to pay you royalties now! 🙂

  17. When I read this post it makes me feel better about our savings rate because if I just calculate what we put away for retirement it is only about 25%. However, if I add the categories of paying down the mortgage and reducing liabilities that actually goes up to about 40% or more (I just did a rough calculation). I fully admit feeling jealous of others who save 50 to 70% of their income, but I think you are right that reducing liabilities should be considered savings although I am not sure others would agree.

  18. We are in the same boat at Amber Tree Leaves. We are kind of forced to use after tax income, as the pensions we have cannot be take into consideration (you cannot touch this money until 65 of 67, so it’s not available for FIRE). It really becomes after tax, net income as a ratio with your household expenses. There is still a can of worms to be opened as how to book for example benefits for day care (income or negative expense?), child care benefits, gifts in cash, etc. Considering Mrs CF is trained in the accounting side of things, we generally keep accounting rules for our savings rate. We even dedicated a page to how we calculate our savings rate, to make it clear to our readers what we do.
    But it’s all not a simple as it appears at first sight.
    Top post Big ERN, well done!

    1. Thanks, Team CF, for the European perspective! Yes, we’re quite privileged in the U.S. to have these various savings/investment vehicles for pre-tax savings. But the safety of a pension is also pretty nice to have. That means the FIRE calculations become a more manageable fixed horizon problem to fund spending between age 40-67.

    1. Great point, Troy! If you are self-employed it’s a lot harder to disentangle labor income and reinvested profits from capital income! I guess you could determine how much of a free market salary you’d pay yourself. Then take the difference between that and your actual living expenses and call it “savings”
      Thanks for sharing!

  19. This is a good post showing the complexities…but even you left out one, I think. “Total compensation” is notoriously hard to calculate for a person but I’d argue that, at a minimum, it needs to include the employer portion of FICA.

    (We could argue about whether that counts as savings or not, I guess, as well! If you say “yes, it is savings” then that’s another 15% of savings for most people right there, once you include the employer and employee portion. If you say “no” then it is another impediment to having a high savings rate.)

    Once you open the “total compensation” can of worms, it is hard to know where to stop. Your employer is paying part of your health insurance…and not because they are charitable. Maybe they have some long-term disability insurance? Unemployment insurance? Companies pay all kinds of things that never show up in anyone’s W-2. That laptop they bought for you? Fringe benefits like phone allowance, airline miles that you accumulate when traveling on business but use for personal travel. Probably tons more examples that I can’t even think of right now.

    If you’re the owner of the company and see it coming out of your account, you are probably going to consider it all part of “total compensation” for the people you hire.

    As most others have pointed out (including your post itself)….it makes you wonder what’s the point of trying to calculate it is anyway…

    1. I left out only one??? Haha, I’m sure I left out many, many more complexities. Good point about all the benefits I get at work. That should be counted as compensation and then also as consumption. That will certainly chip away more of the savings rate. Oh, well there goes another % or two…
      Thanks for stopping by!

  20. I’m sure it’s not nearly as accurate but I take my net take home pay minus out what I spent and then divide that by net take home pay. That’s how I figure out my savings rate. I’m sure my savings rate would theoretically be higher if I included by 401k match/contribution but I figure I can’t use those until I’m 59 1/2. So I’ll “forget” about that while I’m trying to reach FIRE. Right now based off my calculation I’m saving around 70% for the year which makes me happy. Knowing that I’m spending 30% of my take home pay means that I’m that much closer to reaching FIRE 🙂

    1. Wow, that’s a fantastic savings rate. I’d be at around 45% using the S3/(S3+C) measure. Great for you. Sometimes it’s helpful to low-ball the savings rate a little bit to trick you into maintaining savings discipline. 🙂
      Thanks for sharing!!!

    2. …401k match/contribution but I figure I can’t use those until I’m 59 1/2. …

      For a long time, I too believed this was true, or at least that I would pay penalties, if we chose to tap our 401k/403b funds before 59 1/2.

      The good news is that this is simply not true and it opens a whole new realm of options for our situation. My personal favorite is a Roth Conversion Ladder, but there are other options that may suit other folks’ needs better based on their age, tax bracket, or other personal factors. A great starting point to dig into the options is .

  21. You mentioned that you thought excluding capital income from savings rate calculations might be a contentious issue, and then no one brought it up! Well, allow me to fulfill that contentious role.

    Income is income and “capital income” shouldn’t be excluded from the total.

    As you point out elsewhere: money is fungible. You earned it. You didn’t spend it. You reinvested it…you SAVED it. It should be part of the numerator and denominator.

    And the government certainly considers it part of your income (if it’s not protected in a tax-advantaged account). So why wouldn’t you count it too?

    Plus, it’s a huge component of a successful early retirement strategy. In fact it’s THE primary component since the goal is to completely eliminate the need for a wage income at all.

    The fact that “25 of Ben’s 75% are merely a result of past savings efforts” just means that Ben has a nice snowball going. In fact he could probably retire since he earns more in passive capital income than he spends. Good work Ben…that’s the whole point of having a high savings rate in the first place.

    Now obviously unrealized capital gains don’t belong here, which is maybe what you meant when you said that it’s too volatile for equity heavy portfolios? Unrealized gains are absolutely not income. But I’m not sure exactly what you meant by that last parting shot about the volatility of capital income from equity investments. I wouldn’t call dividends especially “volatile”…

    Now, I also agree with you and the numerous comments concluding that this is all kind of a moot point. There are lots of different numerators and denominators that are equally credible yet produce wildly different results. So fussing over a savings rate definition is not especially constructive.

    But with that said, I’m going to fuss about it, because yay internet.

    IMHO…if you’re going to go through the effort of trying to come up with a savings rate, I absolutely believe that capital income earned from previous disciplined savings efforts belongs somewhere in the equation.

    1. Thanks for your comment! Very thoughtful! It proves my point that there are too many different ways of computing a savings rate that it’s too hard to compare the savings rates among different FIRE bloggers. We obviously agree on one issue: What exact formula to use depends on the context. So let me make a few points:

      1: I would never ignore my reinvested capital income. I am still in the accumulation phase and it’s implicit that my savings rate within capital income is 100%. In other words, I like to calculate my savings on a more granular level (savings out of capital and labor income separately). I can always aggregate them later, but at the initial stage, I like to calculate them separately.

      2: One context where the SR is very heavily used in the FIRE community: Starting from $0, if you save x% of your after-tax pay then it takes you N years to reach FIRE (Net Worth = 25x or 30x income). For example x=60%, then N=12 or 13 years. The calculation on the MMM page I mentionsed.
      In this context, you absolutely definitely don’t want to count the capital income as additional savings. That’s because the compound capital gains were already budgeted as getting you faster to the 25x income. We can’t double-count capital gains from the snowball and think that helps us reach FIRE faster even when the savings rate appears higher due to capital gains after a few years of investing.

      3: So, do you imply that realized capital gains belong in the savings rate? Then let me pose the following example: Persons A and B, both make $100k, both save $50k out of labor income. Both have a loss of $200k in their investment portfolio. Person A realizes the loss (Tax Loss Harvesting, even shows up on the tax return, so should be counted), but Person B does not. According to you, person B has a savings rate of 50%. But Person A has total savings of -$150k, out of a total income of -$100k. Uhhm, the denominator just got negative. And the savings rate is +150%. Doesn’t make any sense.
      And the savings rate doesn’t get much more sensible if this were a gain instead of a loss: Person A realizes the gain and now has $250k savings out of $300k income. Some people would call that an 83% savings rate. I certainly wouldn’t. It’s not quite as preposterous as the 150% with the negative denominator, but it’s still nonsensical.
      Also, consider the room for manipulation: I wouldn’t be surprised if people count capital gains in their savings rate but then ignore losses the next year.

  22. 1) Fair enough. I like the idea of describing the savings rate on capital income as implicitly 100%.

    2) You’re right that SR is often used to “project” years to FIRE.

    I’ve never found that exercise particularly useful because it’s based on getting the net worth to a magic number. Net worth isn’t really what’s important to me. Cash flow is the king.

    For me I’ve always seen the path to FI paved in building a growing, passive income stream to the point where that income exceeds expenses. If the income can be expected to grow at a rate that exceeds inflation (reasonable expectation for rental income, dividend growth stocks etc) then once passive income as a percentage of expenses is 100%+, then you’re done.

    When you calculate FI by looking at expenses as a percentage of total net worth you end up wringing your hands for 12 blog posts about safe withdrawal rates 😛

    I guess this kind of illustrates the difference between the Church of Dividend Mantra and the Church of MMM.

    I don’t think either is necessarily right or wrong, just different perspectives.

    3) Realizing a net $100k loss for tax purposes would mean Person A would be writing it off $3k at a time for 30+ years.

    Without any other kind of context indicating the reason for that large of a “tax loss” that is a pretty ridiculous example, but the point is well taken. It does create a situation with a negative income and negative savings which technically equals a positive percentage…That’s silly and obviously not a good reflection of Person A’s real “savings rate” whatever that may mean.

    I still consider realized cap gains/losses income though.

    I have noticed a lot of bloggers who regularly report their passive capital income, but conveniently leave out capital losses when they “tax loss harvest”. That term gets bandied about quite a bit in the blogosphere and a lot of times I think it’s just a euphemism for “I bought the wrong stock and am cutting my losses, but I’m a devout buy and holder so I feel bad admitting that I’m selling for a loss.”

    But I digress.

    Realized cap gains boost net income and realized cap losses reduce it. The knife cuts both ways, and I’m not going to change that perspective because an extreme example created a goofy value for “savings rate”.

    If the realized losses are big enough to overwhelm your wage income and give you net negative income, I think you’re doing something wrong. That’s probably not “tax loss harvesting”; more like “panicking in a market correction.”

    1. Agree: The calculation for how long it takes to reach FIRE is just an illustration. For example, it doesn”t take into account that consumption could be lower in retirement due to a move to a cheaper location.

      About counting the gains/losses in the savings rate: True it was an extreme example. But not that extreme. That $200k loss could have been a 20% drawdown in a $1m portfolio. Not unheard of!

      Also: I’m adamant about not booking paper gains on illiquid, hard to price assets (e.g. real estate), but not so much in publicly traded securities. Case in point: Futures and Options on Futures: Marked-to-market every day. Why should I book my profits in S&P500 futures every day, but delay booking them in S&P500 index mutual funds? Doesn’t make much sense.
      So, I will keep doing what I’m doing: Recognize that I have a savings rate of 100% reinvestment in our capital income and then calculate a separate savings rate for our employment income. 🙂

      Thanks for stopping by! I appreciate the very thoughtful comment, as always!!!

  23. I really like your first chart with the six bucket/boxes, but I’ve always thought about deductions as coming before taxes: I picture D above T. I think your SR #3 makes the moost sense. I think your savings rate is how much you save on the money on which you can actually make decisions: taxes are not optional so you don’t have much to say about how much you will pay in taxes (of course you have some wiggle room with deductions and adjustments). And I am an engineer so I need to see everything from the numerator in the denominator. Plus, if you manage to make your post-retirement income from the right sources (mostly capital gains and qualified dividends) then you can probably forget about taxes and then the calculation is perfectly relevant for the cited MMM estimation (how many years you have to work versus savings rate).
    Finally, I agree on computing mortgage principal as savings (I have 4 mortgages so I’ve given this a thought many times). As for Ben having an additional $100 of capital income from retirement savings, I would only account dividends as income, not all capital gains, but I know I am wrong in this, I haven’t made yet the mental switch needed to realize capital gains are some for of income (it makes me uncomfortable to consume capital for regular expenses).
    Great post!

  24. I see savings rate as just another form of FIRE voyeurism, particularly when it is not accompanied by actual numbers. The real numbers matter because without them there is no context. A 40% savings rate is a lot more impressive if someone is earning 100k vs. $1 million.

    1. Very true! I don’t believe so much in person vs person comparisons for the reasons stated here. But I like to see how my personal SR evolves over time. That’s still useful information. Cheers!

  25. The mortgage question is an interesting one. I too count the repayment part of the mortgage as a saving and the interest as an expense.

    Having said that, I hope that by the time I retire I will have paid off the mortgage which means the interest will no longer be an expense – that means technically I don’t need to save up as much for retirement. But in that case is the interest part of the mortgage still an expense to be counted against the savings rate? I’ve started thinking maybe the interest part of the mortgage should be considered a bit like paying income tax (another cost I won’t have in retirement), and therefore it should reduce my income rather than increase my expenses. Looking at it this way makes the savings rate look more favourable, am I kidding myself though?

    Also, and I’m in the UK so perhaps things work a little different here, but the repayment part of the mortgage increases over time whereas the interest part decreases. This has the effect of making it look like I’m saving slightly more each month and spending slightly less each month (all other things staying the same). I’m not exactly sure of the maths but I think this means that the years to retirement is reduced, is that right do you think?

    I also think about the house in terms of imputed rent, which is a cost and therefore good to keep low. It’s better to have a small house with lots in stocks/shares, than a large house with little in stocks/shares. Fairly self-evident I suppose – it doesn’t really count as saving towards retirement if all your net worth is in a massive house and not in income producing assets. I wonder if there is an optimum ratio to go for in terms of house value vs net worth, should your house make up 25%, 33%, 50% of your net worth? Depends on your values and what makes you happy I guess!

    1. Thanks for stopping by. For some reason, this was initially filtered out as spam.
      I wouldn’t consider the mortgage interest a tax. It’s an expense, essentially renting money from the bank, the equivalent to renting an apartment.

      What you’re referring to is the mortgage amortization math. You start with making mostly interest payments and very little principal paydown. Over time, the principal pay down gets more. I would consider that the equivalent of compounding investment returns in the debt paydown. So your path to FIRE accelerates. But that’s mostly due to compound returns in your investment portfolio.

      Also, you are 100% right about keeping housing costs low. I don’t think there is an ideal percentage for the house in your net worth. It looks like most FIRE folks who are homeowners have houses in the $250-$400k range and a portfolio of $1m or more. Personally, I would like to target $300k in a $3m portfolio, so only 10% of the Net Worth.

  26. I’m late to seeing the post, but appreciate the outline regarding savings rate. I’m also in a huge marginal tax bracket and struggle with these comparisons.

    Fortunate my bonus gets matched, but RSU vesting does not

  27. Very astute post, it is a much tougher number to pin down than you think. Very hard for me to come up with a definitive number for a variety of reasons. I have never really felt a need to do so. Other than a rough guess at it from our day jobs.
    We max our 401k accounts and both get generous matches and that along with debt reduction is certainly savings. I just figured it out that we save about 35-40% of our gross job income as (savings+debt reduction+401K+401K match)/(Gross income+401 k matches). That looks like we are far more frugal than we really are though as the company matches are large and our job pay is also a bit better than average.
    I also do not count dividend or rental income as that all is reinvested. We invest in real estate and are always improving houses or repairing them. When we buy a messed-up house the cash to buy is certainly an investment but we have also signed up for a big liability to repair the place. That will take future income/savings/rent dollars to be spent for the expense to install an HVAC system, roof, plumbing etc. When we are done we have a nice rentable place that generates income and hopefully a large unrealized gain unless we choose to sell and realize it. The gain is somewhat variable depending on if I am wise or foolish but it is murderously taxed if we sell it after holding less than a year.
    The depreciation deduction on existing houses saves on taxes (Savings?) now but the accumulated depreciation is a giant future liability that accrues continuously in the negative (possible expense?) but will only be realized if we choose to sell and it is recaptured. (I/we plan to hold the long term rentals until the grim reaper ups the cost basis on everything with a sweep of his scythe.) Deferred gains from prior 1031 exchanges rolled forward into new properties are another giant unrealized tax liability that the same scythe will remove along with all earthly cares.
    The property taxes and income taxes consume more loot than I would like and we buy Uncle Sam a really nice boat every year and some years we are nice enough to kick in a decent truck for him to pull it. The high marginal tax rate is a real kicker though and like you and many others, I have no desire to feed that beast any more than I have to. Marginal tax rate is pretty much 33% Feds, ( and also 2.35% for medicare+6.2% SSI up to a point), 5% state. 1.5% local, plus 3.8% NIIT when applicable so those day job dollars at the high end are well chewed on by the time we see them. That 3.8% NIIT is a real irritant to me as it pretty much another bite after that income dollar has already been well and truly mauled.
    Really enjoy your stellar and astute blog.

    1. Thanks for the compliment! 🙂
      Wow, thanks for sharing that! I agree it’s hard and probably unnecessary to pin down the exact number. I know we have a high savings rate, so a ball-park number suffices.
      You also point out a giant obstacle to calculating the SR: Lots of people have businesses of all kinds, including your rentals. That makes it all the more difficult to determine what’s savings, what’s expenses.
      And deferring taxes is another accounting nightmare! Will you be able to give the properties to your heirs and get the cost basis reset at that time? That would take care of that tax burden.

      1. Yes, on death, the cost basis of investment property resets to the value of the asset at the time of death. Much like a stock or index fund. Kicking the bucket wipes the accrued depreciation out also as that would have been added to the sale price if I sell before I take a dirt nap. It is a case of deferring taxes permanently which is a rare thing(sad you have to die to get it but that will not concern me at that point.)

  28. I just found this great article. I hope you write another analysis of different ways to characterize the annual draw amount. I find that it varies a lot in retirement. Currently we are able to get the Obamacare subsidy, so that amount is not needed for health spending but will most likely change. We have a large amount of our net worth in IRAs and at age 73 the RMDs will be more than 4%. RMDs will most likely put us in a higher tax bracket which will mean that the amount for “spending” that remains will be different. Similarly, the year we take Social Security will make a difference to both the draw and the taxes as well as the health care expenditure when we switch to Medicare.

    Possibly you have addressed some of this in other articles I have not yet found, or in one of your case studies. Your website is amazing. Thank you so much!

  29. ERN,

    I don’t know if you are still monitoring this article and a comment coming here but what is wrong with taking your Savings (401k, IRA, HSA, home principal, kids college, etc.) / Net Salary (my definition: Gross Salary – taxes)?

    This seems the most simple to me and gets to the heart of savings. If I bring home (after taxes) $10k and I save into the different savings vehicles a total of $3,500 then I would have a 35% savings rate for the month.

    Is that too simplistic? This is a genuine question as this is how I have been calculating my rate.

    1. That depends on the definition of net salary. I think your and my preferred definition is probably close or the even the same. I just want to avoid counting stuff in the numerator without counting it in the denominator. To avoid the issue with potential savings rates > 100%.

  30. For FIRE purposes, shouldn’t the (savings per month)/(post-retirement monthly expenses) ratio matter more than the actual savings rate? Some costs will go down after retiring (work clothes, commute, child care), while other costs could go up (hobbies, travel).

    1. Yes, excellent point. And really relevant for us personally because we moved from a HCOL area to a smaller town in WA State.
      I’d still prefer to do the savings rate as suggested here and then to the living cost adjustment at the back-end. Simply shift your savings multiple target to reflect the changes in pre- vs. post-retirement budgets.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.