Your Savings Rate: The Crown Jewel of Wealth Building

Your savings rate is a crucial metric to know whether you’re on the edge of achieving financial independence or just beginning to gain control of your financial life.

If you don’t have a high savings rate, don’t worry.  You have lots of company.

The average household savings rate in Canada bounced between -0.1% (yes, that’s a negative) to 2.7% from the third quarter of 2017 until the year-end in 2019 according to Statistics Canada.

Ever since the pandemic began (with the lockdowns and lesser ability to travel and spend on entertainment) the average Canadian household savings rate has skyrocketed into the low double-digit range (11-14% in 2021) according to Statistics Canada.  Those high rates will be unlikely to hold in the future when things get back to a more normal state.  

The keys to increasing your savings rate begin with a budget and can be maintained and increased by avoiding lifestyle creep. 

Once finished with this article, you will know how to calculate your savings rate, and even project future savings rates based on your ability to keep your expenses low.  You will also see why working overtime or starting a side hustle can supercharge your finances.

Savings Rate Primer

You will find that no matter what your financial goal may be, the speed at which you reach it depends on your savings rate.

Saving money is a habit that most Canadians with a middle-class income can build.  Your savings rate is the percentage of your gross pay (your salary before taxes and deductions) that you keep after all expenses have been paid.

Alternatively, you can use your net pay (your take-home pay after taxes and deductions) when calculating your savings rate. 

Gross Pay vs. Net Pay: Savings Rate Formula

Let’s calculate your savings rate based on your gross pay and then your net pay. 

Savings Rate Based on Gross Pay

If you earn $60,000 a year in gross pay, then you are making $5,000 a month prior to taxes and deductions. 

If your expenses total $4,000 per month then you have $1,000 leftover.  That $1,000 represents your savings.

Savings rate = monthly savings / monthly gross income

So your savings rate based on gross pay would be $1,000 / $5,000 = 20%

Savings Rate Based on Net Pay

Remember, your net pay is your gross pay after taxes and deductions.  If your gross pay is $60,000 and your tax rate is 30%, then you are making $42,000 ($3,500 per month) in net pay.  Again, assume your savings are $1,000 per month.

Net savings rate = monthly savings / monthly income (net)

Now your savings rate is 29% ($1,000 divided by $3,500). 

Calculating your savings rate based on your gross pay will always give you a lower percentage than if you calculated it over net pay. 

Below is a comparison table between the two methods.  No matter which method you choose, stick with it until you get the hang of tracking it over a longer period of time. 

CategoryGross Pay ($)Net Pay ($)
Annually Income  60,000                          42,000
Monthly Income             5,000                              3,500
Monthly Savings               1,000                           1,000
Savings Rate20%29%
Based on a 30% tax rate.

You may not like using gross pay as a base for your savings rate because taxes and deductions are somewhat out of your control.  While that is true, taxes are going to be a factor throughout your life and even when you pass away. 

If you want to be a little more conservative with your savings rate calculation, then using gross pay would be better.

You have 100% control over your net pay, so it is a better reflection of your ability to manage your money.   After all, the government will get their hands on some of your earnings no matter what.

Why is Your Savings Rate Important?  

Why is your savings rate the most important factor in your quest for financial independence?

Why isn’t it your earned income?

You can spend earned income on many items and services, while your savings are dollars that you have intentionally not spent. 

Just because you earn more than someone else it doesn’t mean that you have more in the bank.  Look at the following comparison between two people, Jill and Hugh. 

Imagine Jill earns $42,000 in net pay, which means she’s taking home $3,500 each month.  After paying for all her monthly expenses, she can tuck away $1,000 in savings.  Her savings rate is 29% ($1,000 divided by $3,500). 

The second person is named Hugh Pockets.  He brings home $6,500 in net pay each month.  That is almost twice as much as Jill, who is bringing home $3,500 a month. 

Hugh enjoys life to the fullest.  Hugh drives a BMW 7 Series, with tints, spinning rims and a sweet, sweet after-market audio system that he uses to blast Taylor Swift songs while he drives slowly down the block.  Everyone on the street knows Hugh. 

Hugh eats out four times a week. He spends $6,000 a month on all his expenses, including his penthouse condo.  He’s left with $500 in savings at the end of the month.  That means his savings rate is roughly 8% ($500/$6,500) of his net pay.   

Net Pay Calculation Table – From Hugh’s Point of View

CategoryJill ($)Hugh Pocket ($)Difference
Annually             42,000        78,00086%
Monthly            3,500                  6,50086%
Savings               1,000500-50%
Savings Rate28.6%7.7%-73%

Despite Hugh making 86% more per month than Jill, Jill saves double the amount of money that Hugh does and her savings rate is almost four times than Hugh’s, at 28.6%.  

Jill is more likely to achieve financial independence because of her high savings rate.  So your savings rate is a very important factor on your march towards financial independence. 

The good news for Hugh is that if he can stop his overspending tendencies, he can easily save more money.  He can start by tracking his expenses using a budget.  Good money habits lead to better outcomes.   

If Hugh managed to track and reduce his expenses to match Jill’s saving rate of 28% he would be stockpiling $1,857 per month.  Since he makes so much more income than Jill, he would be able to save 86% more than her each month. 

If you want to change your lifestyle, and you earn a large salary, you can see extraordinary results quickly without too much effort.

Jill, who earns considerably less, needs to be more financially disciplined to save 28% because necessities are costly up to a point.  She does not have as much wiggle room to spend on discretionary items as Hugh does unless she can figure out a way to earn more income. 

Your savings rate is a powerful indicator of your ability to turn an earned dollar into money that can work for you through investing.  Any savings you generate can be placed in a savings account to earn interest or a Guaranteed Investment Certificate (GIC), Exchange Traded Funds (ETFs), stocks, bonds or real estate.  

Depending on which avenue you choose, you can make more money by earning interest, dividends and/ or capital gains price appreciation. This can have an incredible effect on your ability to build wealth and reach FI. 

Estimated Money Saved Annually Calculation

If you know your savings rate based on your current salary, you can take any income level and quickly calculate how much your estimated total annual savings will be.

Here is the formula:

Estimated amount of money saved annually = Salary amount * your savings rate

Imagine your savings rate is 10% and you have a job with a $50,000 gross salary. 

Estimated amount of money saved annually = 50,000 * 10% = $5,000

You will save $5,000 per year. 

If you expected your salary to increase by $10,000 next year to $60,000 total, then your total savings for the year would be $6,000.

The estimated amount of money saved annually = 60,000 * 10% = $6,000.

If your new salary bumps you up into a higher tax bracket, you will have to account for that.

Lifestyle Creep and Your Savings Rate

Lifestyle creep is the increase in your spending when your income rises.  For instance, you may decide you deserve a bigger home, a better car, the latest designer clothes, new tech gadgets or fancier vacations when you get a promotion.      

You should splurge a little and enjoy the success of a salary increase, but a good rule of thumb is to save at least fifty percent of your raises. Less if you have any non-mortgage consumer debt.  

You need to enjoy some money now because tomorrow isn’t promised. 

You can still buy a bigger house.  Or a fancy car.  Or you could take an expensive vacation, but do not do it all at once.  Practice some delayed gratification. 

Be wary that buying bigger items carries large recurring expenses.  A bigger home carries a larger mortgage, higher utility costs and property taxes.  These expenses need to be paid each month.  It is not a one-time fee like a vacation.

You may trick yourself into thinking that since housing is an essential category, it’s all right to spend a lot because you need live in a good neighbourhood.  Indeed, you need somewhere to live, but does it have to be in a 3,000 square foot house?  Or could your family survive in a 1,400 square foot townhouse?

When you make more money, be careful how you spend it.  Be intentional about how you spend it.

Savings Rate and Lifestyle Creep Example

The table below is divided into four scenarios: your current situation, and three situations that show the effects of lifestyle inflation at levels that are high (HLI), reasonable (RLI) and non-existent (NLI). 

Remember, your savings rate is directly linked with your level of spending.  

In each of the lifestyle inflation scenarios, assume your income is taxed at an average rate of 25% and that your current salary of $60,000 skyrockets to $90,000 after your raise.

The only variable that changes is your level of spending (“expenses” row). 

CategoryCurrent ($)High Lifestyle Inflation ($)Reasonable Lifestyle Inflation ($)No Lifestyle Inflation ($)
Annual Salary      60,000          90,000     90,000         90,000
Taxes and Deductions (25%)      15,000           22,500       22,500          22,500
Net Pay        45,000           67,500        67,500          67,500
Expenses        36,000           54,000        45,000           36,000
Savings          9,000          13,500       22,500            31,500
Savings Rate (Gross)15%15%25%35%
Savings Rate (Net)20%20%33%47%
Pct of Raise Saved(Gross)N/A15%45%75%
Pct of Raise Saved (Net)N/A20%60%100%

You can see from the table that as you control your spending (expenses) your savings rate goes up. 

In the current scenario, you make $60,000 and your gross savings rate is 15% which translates to a savings of $9,000. 

Interestingly, in the current scenario, your necessary and discretionary expenses are fully covered by your $60,000. 

That means that in theory, any raises should generate a boatload of savings provided you don’t go on a wild spending spree. 

When you earn a promotion, your salary jumps to $90,000 and your gross savings rate remains at 15% in the HLI scenario.  This was done to illustrate the effect that lifestyle creep would have on your finances.   

That translates into $13,500 in annual savings, a 50% jump over the current situation’s savings of $9,000.  However, you left a lot of money on the table by spending $18,000 more than your pre-raise situation.

Your gross pay increased by $30,000 and you saved an extra $4,500, meaning you saved 15% of your raise.

You can see from the entire table that your total savings vary substantially between $13,500 and $31,500 per year depending on how much lifestyle creep you allow.  Your gross savings rate increases from 15% in the HLI scenario all the way to 35% in the NLI scenario. 

The idea is to balance between living your life now and the future and that is why saving 50% of your raise is a good minimum target to aim for.  In the RLI scenario you save 45% of your gross raise, and in the NLI you save 75% of your gross raise.

In the RLI situation, you save $9,000 more per year over the HLI scenario.  Saving and investing $9,000 per year each year for 25 years with a 6% return will leave you with a balance of over $545,792. 

That is just the difference between the high and reasonable lifestyle inflation scenarios.  If you compare the NLI and HLI scenarios, you would save $18,000 more per year in the NLI scenario.  With the same investing parameters, you would have over $1.09 million after 25 years.

That is the power of increasing your savings rate. 

Your Marginal Propensity to Save

Remember the golden lesson learned above. 

Once your basic and discretionary expenses are covered by your original income, any additional income can have a great positive effect on your savings rate, provided you keep lifestyle creep at bay.

Additional income can come from a raise, side-hustle or working a second job.

In the Current Scenario, the $36,000 in expenses represents your break-even point where your basic needs and discretionary expenses are covered.  This represents the happy medium in your life.

Now, there is an economic concept known as Marginal Propensity to Save (MPS).  Your MPS measures your savings from each additional dollar of income you earn.  It is expressed as a percentage. 

Here is the formula:

MPS = (Dollar change in savings) / (Dollar change in income) *100

If your marginal propensity to save is 5%, then you save $0.05 for each additional dollar earned. 

The MPS is calculated based on your disposable or after-tax income (net pay).  This represents your true ability to save because taxes have been factored in.  You have less control over the amount you are taxed on, so your net pay gives a more accurate picture of your money management skills. 

Marginal Propensity to Save with a Reasonable Amount of Spending

All of your housing, food, utility, transportation, health care and entertainment costs are covered when you made $60,000 per year.  Therefore, any spending that you do after you earn a raise would be non-essential by nature if you keep your current standard of living. 

In the Reasonable Lifestyle Inflation (RLI) scenario, you see just that.  Again, the calculations are based on net pay.  

CategoryCurrent ($)Reasonable Lifestyle Inflation ($)Change ($)Change (%)
Annual Salary    60,000      90,000           30,00050.00
Taxes and Deductions           15,000         22,500           7,50050.00
Disposable Income (Net Pay)           45,000          67,500          22,50050.00
Expenses         36,000           45,000            9,00025.00
Savings             9,000          22,500          13,500150.00
Savings Rate (Net)20%33.33% 66.67
 Marginal Propensity to Save (MPS) 60% 

MPS = (Dollar change in savings / Dollar change in income) * 100

 = $13,500 / $22,500 * 100

=0.6 * 100 or 60%

Your spending increases by $9,000, from $36,000 to $45,000 per year.  Your net pay increases from $45,000 to $67,000 per year, or $22,500.   

You spend 40% and save 60% of your raise. 

Your net savings rate increases from 20% to 33%. Yet, your overall savings explodes by 150% from $9,000 to $22,500. 

With the RLI scenario, your net salary increased by 50% but your total savings increased by 150% since you had already covered your basic needs with your current salary.   That is how side hustles or overtime dollars earned can make an enormous difference in your life.  Small increases in income can yield huge amounts of money saved–which can then be invested.

Marginal Propensity to Save with No Spending

CategoryCurrent ($)No Lifestyle Inflation ($)Change ($)Change (%)
Annual Salary  60,000  90,000  30,00050.00
Taxes and Deductions  15,000 22,500    7,50050.00
Disposable Income (Net Pay) 45,000 67,500  22,50050.00
Expenses  36,000  36,000         –  0.00
Savings    9,00031,500 22,500250.00
Savings Rate (Net)20%46.67% 133.33
 Marginal Propensity to Save (MPS) 100% 

When you don’t spend any of your raise, your net income increases by 50%, yet your overall savings skyrockets 250% to $31,500 from $9,000.  That is a $22,500 increase.  In other words, for every 1% that your income increases, your annual savings increases by 5%. 

That is the power of your marginal propensity to save.

Savings Rate and Financial Independence

Mr. Money Mustache wrote perhaps the greatest blog post of all time related to the concept of Financial Independence and savings rates here.

In the post, there is a table that showed how many working years you would have left until retirement based on your savings rate, with assumptions made for the rates for investment returns and a safe withdrawal rate percentage in retirement.  

If you save 100% of your income right now, you could theoretically retire today.  If you save nothing currently, you can never retire. 

Of course, there are many savings rates in between.   It is best if you find an online calculator and experiment with your numbers to find out when you can retire. 

As you can see, your savings rate is very important on your way to achieving financial independence.

Savings Rate Conclusion

Now that you know how important your savings rate is and how to calculate it, all that is left is for you to get your savings rate as high as you can, while still enjoying life today. 

You can accomplish a lot of this by increasing your income, reducing your expenses and avoiding lifestyle creep in ways that won’t affect your overall happiness. 

What are some things that you have done to boost your savings rate? Let us know in the comment section below.  

Savings Rate FAQs

How do I calculate my savings ratio?

Your savings rate is your monthly savings divided by your monthly net income (after taxes).  If you save $1,000 per month and your net income is $4,000 then your savings rate is $1,000/ $4,000 = 25%. 

If you want to achieve FIRE your savings rate likelys needs to be up in the 50% – 70% range.

What is the benefit of a high savings rate?

If you can keep a high savings rate, you will give yourself a lot of opportunity and flexibility to change your financial fortunes for the better.  A high savings rate will allow you to pay off any outstanding debt, build an emergency fund and invest to achieve financial independence or retire comfortably.

How can I increase my savings rate?

You can increase your savings rate by getting a raise, switching jobs or starting a side hustle.  You can also reduce your living expenses.

You can automate your savings so that you pay yourself first, cook more meals, try and reduce the number of cars your household has, buy a home that is modest and by cancelling all subscriptions that are no longer useful to you.

In the long-term you can pay off your outstanding debt in the medium term and free up more cash that can be redirected to savings and investments.

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