Your saving rate: The most important number in personal finance

In order to survive and thrive, you need to earn a profit.

You already know profit is the lifeblood of every business. It's like food and water for the human body. Although proper nutrition isn't the purpose of life, we couldn't exist without it. Food and water give us strength to do the stuff that matters most. So too, profit isn't necessarily the purpose of business — but a company can't survive without it.

Here's a secret: People need profit too.

In personal finance, “profit” is typically called “savings”. That's too bad. When people hear about savings, their eyes glaze over and their brains turn to mush. Bor-ing! But if you talk about profit instead, people get jazzed: “Of course, I want to earn a profit! Who wouldn't?”

Profit is easy to calculate. It's net income, the difference between what you earn and what you spend. You can compute your profit with this simple formula:

PROFIT = INCOME – EXPENSES

If you earned $4000 last month and spent $3000, you had a profit of $1000. If you earned $4000 and spent $4500, you had a loss of $500.

There are only two ways a business can boost profits, and there are only two ways you can boost personal profitability:

  • Spend less. A business can increase profits by slashing overhead: finding new suppliers, renting cheaper office space, laying off employees. You can increase your personal profit by spending less on groceries, cutting cable television, or refinancing your mortgage.
  • Earn more. To generate increased revenue, a business might develop new products or find new ways to market its services. At home, you could make more by working overtime, taking a second job, or selling your motorcycle.

When you earn a profit, you don't have to worry about how you'll pay your bills. Profit lets you chip away at the chains of debt. Profit removes the wall of worry and grants you control of your life. Profit frees you to do work that you want instead of being trapped by a job you hate. When you make a profit, you truly become the boss of your own life.

With even a small surplus, the balance of power shifts in your favor.

Tom the Turtle: Profit is Power

The Most Important Number in Personal Finance

If you've ever calculated your net worth, you know that number is a snapshot of your current wealth. But it's more than that. Your net worth is the grand total of years (or decades) of profits and losses.

As the authors of Your Money or Your Life put it, “[Your net worth] is what you currently have to show for your lifetime income; the rest is memories and illusions.” Ouch!

The greater the gap between your earning and spending, the faster your net worth grows (or shrinks). This may seem obvious, but it's important. Everything you do — clipping coupons, asking for a raise, saving for a retirement — should be done to increase your profit and wealth.

But profit doesn't mean much on its own. Is a $1000 monthly profit good or bad? Well, it depends on your circumstances.

  • If your income is $2000 per month (or $24,000 per year), a $1000 monthly profit is great. That's a saving rate of 50%. Congratulations!
  • On the other hand, if your income is $20,000 per month (or $240,000 per year), a $1000 monthly profit gives you a saving rate of 5%. That's average at best.

You see, it's not your total income that determines how wealthy you are and will become. Nor is it your monthly surplus. No, the true measure of progress is your saving rate — how much you save as a percentage of your income.

In business, saving rate is called profit margin. I think it's useful for everyday people — especially folks who have decided to act like the CFO of their own lives — to think of saving rate as profit margin too.

Pull out your personal mission statement. Look at your goals. Your profit margin directly affects how quickly you'll achieve these aims. A saving rate of 20% will allow you to reach your destination twice as quickly as a saving rate of 10%. And if you can save 40% or 60%, you'll get there even quicker.

The growth of your wealth snowball is directly dependent on the size of your saving rate.

Profit is Power

Now I'd like you to meet my friend Pete:

Mr. Money Mustache

Some of you may know Pete as Mr. Money Mustache.

Pete's personal mission is to enjoy a rich life with his small family in a small house in a small town in Colorado. He wants to pass his days slicing through canyons on his bicycle, building things in his workshop, and sharing quiet moments with his wife and son. And Pete doesn't want to be tied to a job.

Following the standard advice to save between 10% and 20% of his income, it would have taken decades for Pete to achieve these goals. Pete is an impatient man. He didn't want to wait that long, so he deliberately pumped up his saving rate.

After college, Pete and his wife worked long hours at jobs that paid well. They moved to a town where the cost of living was low and they could bike anywhere they needed. They bought a modest home. The Mustache family generated a lot of revenue while keeping overhead low.

As a result, Pete and his wife set aside more than half of their combined take-home pay. After ten years with profit margins near 70%, they were able to “retire”. He was thirty years old. Now, a decade later, Pete and his wife continue to pursue their mission, happily ignoring detractors who say what they've done is impossible.

The more you save — the higher your profit margin — the sooner you can have the things you really want out of life.

This is the bottom line, the entire thesis of the Money Boss method: Profit is power.

Profit is Power

Computing Your Profit Margin

My mission at Get Rich Slowly is to give you the power to choose the lifestyle you want. That means helping you boost your saving rate. If you promise to do the work needed to generate greater “profits”, I promise to share the strategies and mindsets that will help you do so.

To find your current saving rate, you need two other numbers: your monthly income and your monthly expenses. For now, let's look at only last month. (You're free to run the numbers on past months or years, but for this exercise last month is enough.)

Here's how to find your income and expenses:

  • If you're a money geek who already generates a monthly income statement (a.k.a. profit-and-loss statement), just grab your total income and total expenses from the form.
  • Many of you track your money in Quicken or through services like Personal Capital. These too make it easy to find your monthly income and expenses. Some will even compute your profit for you. Here, for instance, are my own numbers from Personal Capital. You can see I had a $3214 profit in this example month, which means my saving rate was about 32%. (By the way, these numbers aren't normal for me. Both income and spending were high!)

Monthly Cash Flow

  • If your finances aren't yet automated, it's not too tough to run numbers by hand. Collect your brokerage, bank, and credit-card statements from last month. Use these to total your income and expenses. (You shouldn't have to do this line by line. Most statements total income and expenses separately in some fashion.)
  • What if you don't track your money? Start! If you owned a business, you'd keep books. Well, a money boss keeps books too. It's the only way to spot trends and to measure progress. Pick a tracking method — many GRS readers like YNAB — and make tracking part of your weekly financial routine.

Now it's time for a little math. To find your monthly profit, subtract your income from your expenses. (If your income was $3500 and your expenses were $3000, your profit was $500.) To find your profit margin (or saving rate), divide your profit by your income. (Using the previous example, you'd divide $500 by $3500 to get 0.14286 — a profit margin of 14.3%.)

Burn this number onto your brain. We're going to spend the months and years ahead making your profit margin grow.

If you want to get fancy, run the numbers again. This time subtract your mortgage and car loan and credit-card payments (and so on) from your expenses before calculating profit and profit margin. See how much profit you'll have once you've paid off your debt? Cool, huh?

Note: During the month of March, I'm migrating old Money Boss material to Get Rich Slowly — including the articles that describe the “Money Boss method”. This is the third of those articles.

Look for further installments in the “Money Boss method” series twice a week until they've all been transferred from the old site.

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Jason@WinningPersonalFinance
2 years ago

I agree that savings rate / profit margin are the most important measures to get to FI. I’d argue a bit that something is more important for Winning Personal Finance though. Your happiness. I may be able to achieve a 70% savings rate but I’d probably hate my life if I did so. Finding balance is key. Save a a rate to maximize your long term overall happiness and you win!

S.G.
S.G.
2 years ago

And you might hate it after as well. First, switching gears from long weeks to no work obligations is jarring (there are many sources that address how to transition properly). Second, it is easy to lose purpose which your psyche needs.

In other words, getting what you want might not give you what you need.

Robert
Robert
2 years ago

It’s so important to pick a rate that is sustainable for you. Even a few years can be a very long time to be consistently unhappy.

I often repeat a quote from Greg Glassman, founder of CrossFit, “Fix a low trajectory over the horizon or gravity will fix it for you.”

Dave @ Married with Money
Dave @ Married with Money
2 years ago

Totally agree – it’s not something I was familiar with until last year, but it makes so much sense. The math behind it is simple yet elegant and pretty fascinating.

I’m on an ongoing mission to increase my savings rate, even if only slightly, each month. I’d love to get to 50% or more. It’ll be a bit tough without raising our income I think, but it’s doable. The nice thing now is that any extra income we do make can go 100% to savings.

The Poor Swiss
The Poor Swiss
2 years ago

I could not agree more! Savings rate is the key. I only discovered this too late. Before, I was only saving a flat amount each month and did not really update this number based on my increasing salary. The results are a very bad savings rate. Now, I’m starting to increase it and there is some hope for early retirement now.

I agree with [email protected] that happiness should also be taken into account. A good balance between happiness and savings rate is necessary.

Joe
Joe
2 years ago

Looks like you didn’t account for tax. That’s okay, no big deal. I agree that saving rate is a very important number in personal finance. The higher, better. Saving 10-20% just doesn’t cut it anymore. Life is more uncertain these days.
Happiness is key also. You don’t want to push your spending down so low that you can’t enjoy life.

Vivian
Vivian
2 years ago
Reply to  Joe

I’ve always assumed that the “income” part of the equation is the after-tax amount.

Syed
Syed
2 years ago

Knowing your savings rate and making a commitment to grow it is a very powerful decision. It will shape every decision of your life, even little things like getting your daily coffee or eating out. This is THE way to financial freedom.

S.G.
S.G.
2 years ago

Others have mentioned the consideration of happiness when looking at longer hours, but I would say it’s both more and less than happiness, which is really just a fleeting emotion. It’s about comfort. Now we can change what makes us comfortable through changes in attitude and we can develop cheaper tastes in many things. But ultimately working hours past your personal comfort level, and everyone will have an individual limit, will make you UN-happy and miserable. Rest, healthy food, exercise, etc are all components to comfort and will compete with your time and attention against work, especially if you’re doing… Read more »

Accidental FIRE
Accidental FIRE
2 years ago

Great post. My salary is now cut in half being part time but I’ve tried to keep my saving rate as high as possible. I can’t come close to what I was doing before, but I’m inching it up every month!

WantNotToWantNot
WantNotToWantNot
2 years ago

I bet knowing your profit (savings rate) is a great incentive to save, an inspiring benchmark to track. What a great idea… But, I admit I have never figured out that number for myself. Instead I have just jacked up my automatic savings by increments, over and over (especially when raises came), and felt free to spend the rest of it, making the money stretch with frugal choices and saving ahead for big purchases. On the other hand, I keep an eagle eye on our expenses (through IBank) and the diversification of our investments (though my own spreadsheets). Somehow, it… Read more »

CalLadyQED
CalLadyQED
2 years ago

JD’s mantra used to be “do what works for you” because “no one cares about your money more than you do.” I think you route fits that very nicely.

lmoot
lmoot
2 years ago

I base my savings rate mostly on timelines. When do I want to achieve a certain goal by? How much will it cost? Divide one by the other to see how much I need to save.

I don’t use this method to undersave (I always try to save the current max I can comfortably save$, rather I use it as fuel to drive me to search for ways to reduce expenses, and/or increase earnings.

You need to have a plan in order to come up with a formula.

Mike Roberts
Mike Roberts
2 years ago

Great post. This aligns nicely with a truism I got from Rich Dad, Poor Dad years ago: It’s not how much you make, it’s how much you keep.

There are a lot of people out there who appear rich and make huge incomes, but their savings rate is nil. People on far smaller incomes can often out save those with high salaries. You don’t need to have a big salary to retire well (though it can certainly help if you’re a disciplined saver).

Michael King
Michael King
2 years ago

Just curious what you include in income and savings rate. Do you take out all the taxes before calculating along with additional health care costs (vision plan, medical, dental…etc)
Also for savings do you consider your 401k or do you calculate after that has been taken out? If your employer matches do you consider that as savings or separate? I could see including it because it is a savings your getting however I could also see it isnt coming from your income to not include it.

anket
anket
2 years ago

As someone who is interested in adapting concepts associated with high finance, to my personal situation. I really appreciate this article. Perhaps you could include a primer on “balance sheets” and what constitutes a “strong balance sheet” in the “coming to terms” article you mentioned?

Lily | The Frugal Gene
Lily | The Frugal Gene
2 years ago

The savings rate works really well in personal finance and tracking your money muscles. Our gross is about 68% for 2018 but ahhh..gosh we haven’t found our net year. Definitely would be over 80% is my guess! We’re waiting to finish taxes because Turbo Tax apparently will tell you your net savings rates after.

Dave
Dave
2 years ago

The markets go up, down, and sometimes even sideways. There is little that an investor can do to manage that other than asset allocation. Saving is one variable that an investor can control. If you want to save more, reduce expenses.

Susan @ FI Ideas
Susan @ FI Ideas
2 years ago

Profit margin — that’s a brilliant way to look at savings rate. A lot of my friends ask us about how we retired early, and think we figured out some particularly great stock pick or something secret. It’s all about how much you save. But until the word gets out to the mainstream, I suppose it is a bit of a secret.

Jason
Jason
2 years ago

I have been reading your blog since 2008 and learned a great deal. I leaned about saving rate from another site and have been consistently saving once I was debt free, 2009, and currently at a 40% saving rate per paycheck though I tend to save more as some surplus money goes into saving monthly and I do not include my 6% 401k match

Kara
Kara
2 years ago

I calculate our savings rate based on take home pay (after taxes and medical insurance). I track 2 figures for savings rate- one is the extra paid down on our mortgage principle and retirement savings that month, the other includes those two figure plus many ‘sinking funds’ we add to regularly (home repairs, car purchase/repairs, college savings, medical/vet expenses, the like). Our household income fluctuates month-to-month, but generally, we put away roughly 25% on average for retirement/extra on mortgage each month, and roughly 48% or so for all the ‘savings’ categories lumped together. I am REALLY looking forward to be… Read more »

Lisa S.
Lisa S.
1 year ago

I’ve been using this concept to cheer myself as I start a very long and unfortunately late crawl out of debt into stability and hopefully agency or security (sadly won’t have time in my life for more, I think – https://www.getrichslowly.org/stages-of-financial-freedom/) I find it so encouraging to look at my still-meagre saving abilities as a percentage of what I earn, rather than the small lump sum. So thank you!! The thing is, this morning while researching a post I’d like to do on this for Medium, I came across a totally different (and way grimmer) definition of how to calculate… Read more »

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