For years, I've argued that your saving rate is the most important number in personal finance. “Saving rate” in the world of personal finance is the same as profit in the world of business. We all understand that a company needs to earn a profit in order to grow and thrive, but what most people fail to realize is that people need profit too.
The greater the gap between your earning and spending, the faster you're able to grow your wealth snowball and achieve your goals.
Last week, the always-excellent Michael Kitces published an interesting article that argues spending rates matter more than saving rates. He writes:
Most households struggle to save because there is no money left at the end of the month to save in the first place. Because technically their problem isn’t a savings rate that’s too low; it’s a spending rate that’s too high.
When I began reading Kitces' article, I thought he was picking nits. After all, saving rate and spending rate feel are two sides of the same coin. Turns out, however, Kitces has a good point.
Saving Rate vs. Spending Rate
Your saving rate — and note that it's not “savings rate” — is calculated by dividing your profit (your income less your expenses) by your income.
Your spending rate is calculated by dividing your spending by your income.
As you can see from the equations, saving rate and spending rate are simply the inverse of one another. If you have an 80% spending rate, then you have a 20% saving rate. If you have a 5% saving rate, then you have a 95% spending rate.
Because of this, it's easy to dismiss tracking your spending rate as a needless exercise. That number is implicit in your saving rate!
But Kitces argues that shifting the attention from saving to spending makes sense because saving is, essentially, a side effect. The two numbers you actually control in this equation are your earning and spending. Saving is a byproduct. It's not a primary factor but a secondary one. This observation is subtle but it's important. [Read more…]