Is Savings rate better calculated via Gross or Net?

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katzmandu
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Is Savings rate better calculated via Gross or Net?

Post by katzmandu » Mon Aug 17, 2015 8:38 am

After much effort, I've been able to get my savings rate up to about 30.5% of gross. Is this the accurate measure of ones savings rate or or should be be calculating by net. Higher % though I dont know that its a useful indicator.

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Re: Is Savings rate better calculated via Gross or Net?

Post by Grt2bOutdoors » Mon Aug 17, 2015 8:44 am

Net or gross, it's still the same - you aren't spending what you either come home with or what you make before taxes.
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Go Blue 99
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Re: Is Savings rate better calculated via Gross or Net?

Post by Go Blue 99 » Mon Aug 17, 2015 8:46 am

I prefer to use Gross. Calculating using Net can be thrown off based on your pretax deductions (401k, health, flex spending acct, daycare spending acct, etc).

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Meaty
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Re: Is Savings rate better calculated via Gross or Net?

Post by Meaty » Mon Aug 17, 2015 8:50 am

Go Blue 99 wrote:I prefer to use Gross. Calculating using Net can be thrown off based on your pretax deductions (401k, health, flex spending acct, daycare spending acct, etc).
+1. I also think using gross is more conservative and, therefore, enhances likelihood of success. As an example 15% before deducting taxes, insurance, fsa etc is obviously a larger number
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Aptenodytes
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Re: Is Savings rate better calculated via Gross or Net?

Post by Aptenodytes » Mon Aug 17, 2015 9:05 am

If you want it to guide your behavior then neither. The denominator should be the total amount you could conceivably save, and you should set a target, and revisit the target once a year.

If you don't want to use the number as a guide then it doesn't matter which you choose.

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nisiprius
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Re: Is Savings rate better calculated via Gross or Net?

Post by nisiprius » Mon Aug 17, 2015 9:14 am

I don't think any financial advice is precise enough for that kind of detail to matter.

30% of anything is huge, that's fantastic! I think it's safe to say that if you're saving 30% of take-home and you can keep it up, you're doing everything prudent and much more. The uncertainties of life are so great that there is no pile so big that anyone can guarantee that it's big enough.

Rather than fuss over the rules of the game for interpreting some rule-of-thumb or another, I think the best way is to derive it yourself from first principles. TIAA-CREF had a booklet about this many decades ago and I wish I'd saved it, but it wasn't complicated.

Just go back to fundamentals.

Do a rough back-of-the-envelope calculation... of course I mean "spreadsheet," not "envelope."

Not only will you be customizing the calculation to your personal situation, at the same time you will understand how imprecise it all is and just how rough all guesses are.

Work in real dollars--pretend there's no inflation, or that your salary and your investments keep up with inflation but do not assume they will do better.

Take a rough guess at your retirement age, let's say 65. Take a rough guess at the number of working years ahead of you, let's say 45. Take a rough guess at the number of retirement years for which your savings will need to last, let's say 30. Consider your current take-home pay, after ALL deductions, and your current standard of living.

Take a rough guess as to what percentage of that you will need in retirement--this is super controversial but one traditional number that isn't crazy is 70% of working-years take-home. If you don't want to use 70% keep in mind that your taxes will probably be lower in retirement, and that a lot of things you need in working years (e.g. two cars for two wage-earners) are not needed in retirement--but on the other hand, old folks "need" more comfort and coddling.

Now, just do the math--I used to take the time to do the algebra but it's easy enough to do it by trial and error on a spreadsheet.

How much do you need to save over a period 45 years to equal the amount you will need to spend over a period of 30 years?

Of course the initial answer you get is shocking--it is 70% x 30/75 = 28%. However, it is reasonable to count the roughly 6% of your salary that goes into Social Security as savings, and double that to add the employer's contribution; that's 12%, and then adjust that so that you have it as a percentage of take-home, not percentage of salary. You're saving that much in your Social Security, and you need to make up the difference between that and 28%.

The point is to take the time to plug in your own numbers.

As you do this you will be tortured by the realization that everything you're plugging in is uncertain to within factors of 2 or worse. Don't go nuts trying to make those wild guesses more precise. They're wild guesses and they will still be wild guesses. So what if they are coming out of a computer program that is calculating them to seven significant figures based on 87 factors and 23 historic databases? They're still wild guesses.

Lots of people do not live even 10 years in retirement--I can name four from within my close friends and family, and they all ate right and kept fit. Lots of people do live more than 30 years past age 65--particularly women, of course. Nobody knows whether Social Security will be paying 100% of promised benefits, 70%, or zip. Nobody knows what Medicare premiums will be. Nobody knows the name of the president who will be elected in 2036, what party will be in power, so you certainly don't know what the marginal tax rates will be. Nobody knows what inflation or investment returns will be. All you can do is make some kind of wild guesses and hope that the over-pessimistic and over-optimistic guess sort of balance.
Last edited by nisiprius on Mon Aug 17, 2015 9:18 am, edited 1 time in total.
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Re: Is Savings rate better calculated via Gross or Net?

Post by ivyhedge » Mon Aug 17, 2015 9:18 am

Meaty wrote:
Go Blue 99 wrote:I prefer to use Gross. Calculating using Net can be thrown off based on your pretax deductions (401k, health, flex spending acct, daycare spending acct, etc).
+1. I also think using gross is more conservative and, therefore, enhances likelihood of success. As an example 15% before deducting taxes, insurance, fsa etc is obviously a larger number
Another vote for gross: for the same reason.
Polymath.

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Re: Is Savings rate better calculated via Gross or Net?

Post by jebmke » Mon Aug 17, 2015 9:22 am

In my opinion, the only thing that really matters is whether the rate of accumulation, in absolute dollars, will be enough to meet your objectives. During my accumulation years I don't think I ever calculated or considered a "savings rate" in percentage terms.
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goingup
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Re: Is Savings rate better calculated via Gross or Net?

Post by goingup » Mon Aug 17, 2015 9:24 am

I use gross income to calculate our savings rate, try to roughly keep this course: save a third, spend a third, give a third to taxes.

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katzmandu
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Re: Is Savings rate better calculated via Gross or Net?

Post by katzmandu » Mon Aug 17, 2015 9:37 am

jebmke wrote:In my opinion, the only thing that really matters is whether the rate of accumulation, in absolute dollars, will be enough to meet your objectives. During my accumulation years I don't think I ever calculated or considered a "savings rate" in percentage terms.
I was asking as I see a lot about savings rates posted on ERE type sites. Perhaps it less to keep score and more if you save @ x% rate, you will accumulate enough fast enough to be able to exit the working world and have your assets produce enough so that you dont struggle or live a similar lifestyle, assuming of course past market returns.

Obviously only absolute dollars truly matter. Many of the assumptions from the financial sites explain if you save 15% plus co match, etc, you will 'have a million after 45 years working'. Who wants to work that long? Not I :)

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Re: Is Savings rate better calculated via Gross or Net?

Post by Traveller » Mon Aug 17, 2015 9:43 am

I don't think it really matters, just pick one and stay with it. It's kind of like showing the speed of your car in MPH vs. KPH - you are still going the same speed and you are still saving the same out of $$. Just go as fast as you can!

As an aside, my uber spreadsheet calculates my savings rate over net income (net being gross minus taxes, no other deductions considered).

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Re: Is Savings rate better calculated via Gross or Net?

Post by KlangFool » Mon Aug 17, 2015 9:44 am

ivyhedge wrote:
Meaty wrote:
Go Blue 99 wrote:I prefer to use Gross. Calculating using Net can be thrown off based on your pretax deductions (401k, health, flex spending acct, daycare spending acct, etc).
+1. I also think using gross is more conservative and, therefore, enhances likelihood of success. As an example 15% before deducting taxes, insurance, fsa etc is obviously a larger number
Another vote for gross: for the same reason.
Another vote for gross. Another advantage for gross is with this number, you can calculate expense easily...

Expense = Gross income - gross saving - tax

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Re: Is Savings rate better calculated via Gross or Net?

Post by LateStarter1975 » Mon Aug 17, 2015 9:59 am

goingup wrote:I use gross income to calculate our savings rate, try to roughly keep this course: save a third, spend a third, give a third to taxes.
+1
This is a refreshingly simplified way to look at it. I like this
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Re: Is Savings rate better calculated via Gross or Net?

Post by wolfeman » Mon Aug 17, 2015 10:11 am

I prefer gross, and I also add any employee match to gross. If you don't use gross, I'm not sure how you accurately account for savings that are taken out pretax.

I strive for 30% savings, 30% regular spending, 15% fun money (vacations, etc.), 25% tax (including SS, medicare)

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Re: Is Savings rate better calculated via Gross or Net?

Post by KlangFool » Mon Aug 17, 2015 10:11 am

LateStarter1975 wrote:
goingup wrote:I use gross income to calculate our savings rate, try to roughly keep this course: save a third, spend a third, give a third to taxes.
+1
This is a refreshingly simplified way to look at it. I like this
Another nice thing of this approach is

Annual gross savings = annual expense.

At or before 25 years, you will have enough.

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Re: Is Savings rate better calculated via Gross or Net?

Post by TomatoTomahto » Mon Aug 17, 2015 10:17 am

I don't do this religiously, but I take NW this year versus a year ago. Hopefully this number is a positive and large number. I don't make a big fuss about comparing it to annual gross, but it gives me a quick reassurance that we are saving well. The added benefit is, since it counts portfolio growth, you can do it even after retirement.
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Re: Is Savings rate better calculated via Gross or Net?

Post by sesq » Mon Aug 17, 2015 10:33 am

I haven't done it in a while, but when I did keep a budget, its very easy to add another column to the spreadsheet and calculate it both ways. I did this for both my savings rate and my expenses. For some reason looking at my expenses as a percentage of income was helpful to understand my priorities, especially early in my career. Later as my income rose saying the cell phone bill was sub 1% of pay got less revealing.

It was also interesting to look at the budget items as a percentage of total spending too (usually net of taxes).

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Re: Is Savings rate better calculated via Gross or Net?

Post by grog » Mon Aug 17, 2015 10:39 am

Around tax time this year, I worked out a retrospective budget of sorts to (roughly) track where every dollar of my gross income is going. Before I would only budget month to month based on my net income and my expenditures. I still do that, but the monthly cash flows were volatile and I didn't have a good sense of my overall level of savings. I think looking at the gross gave me a nice big picture of my year to year finances. For last year,

Gross Income = 100%

Savings 40.3%
Taxes and Charitable 26.1%
Rent 15.0%
Insurance 3.5%
Other Spending 15.1%

I define savings as 401K and IRA contributions plus change in cash balances. HSA I count as an insurance cost. Taxes are all the state and federal income plus FICA taxes I paid. With this I can easily project the effect of, say, renting a nicer place and see what that would do to my savings rate.

I intend to do this once a year when I do my taxes, plus a forecast version for the coming year. Right now, my savings goal isn't really any fixed percentage, but I do want to max my 401K and IRA and do so without having a negative change in cash (i.e., fund with income, not out of cash savings). That is the floor. In my forecast I set a loose goal for cash savings in dollar terms.

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Re: Is Savings rate better calculated via Gross or Net?

Post by FuzzyButtons » Mon Aug 17, 2015 10:47 am

I think most of the ER sites use net savings rate as their comparison number. This is more because it's quicker to calculate, and since savings rate is just a rule-of-thumb you might as well go for the fast and easy route.

But I think savings rate only has meaning if you are using it to predict how much you are putting away vs your expenses for retirement. So before you can use it, you need to have an idea what your expenses will be in retirement when you are living off your savings. The net savings rate assumes that you'll only spend what you are spending today after tax, and that doesn't seem accurate to me - though it might be for an extreme early retirement person who will be in the 0% tax range.

For myself, my spending will change in two ways in retirement. First, my taxes will get less. I'll have no payroll taxes, and my income tax will be smaller because I'll only be withdrawing from my 401(k) enough for my expenses. All of my savings is tax-deferred, so that's easy for me to calculate. Second, my health insurance costs will go up (and health costs as well). I don't know by how much, but I'm sure I'll be paying way more than the $50 a month I pay with my company plan now. I've decided as a guess that my health care costs will be exactly the same as the payroll taxes I pay today, plus the savings on income tax. That's as good a guess as any for now, and I'll refine it as I get closer.

Those two assumptions mean my spending in retirement will be the same as my spending now, including all taxes. So a gross savings rate works perfect. I'm saving about 43% :happy

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Re: Is Savings rate better calculated via Gross or Net?

Post by vitaflo » Mon Aug 17, 2015 11:24 am

KlangFool wrote: Another vote for gross. Another advantage for gross is with this number, you can calculate expense easily...

Expense = Gross income - gross saving - tax
I do the opposite. Savings = Gross income - spending - tax

Basically, I use savings as "everything left over" after outflows from gross.

FWIW, I use net when calculating savings rate. Taxes are what they are, spending is variable and more under my control. I feel it gives me a better handle on my spending.

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tax adjusted deferred gross + taxable gross

Post by Spirit Rider » Mon Aug 17, 2015 12:34 pm

Being an engineer and a contrarian I have always used a strategy for lack of a better name we will call this "tax adjusted deferred gross + taxable gross". An example best illustrates this.

Say there is a desired "savings rate" of 25% and a marginal tax rate of 33%. A 15% gross tax deferred contribution only reduces net compensation by 10% leaving a balance of 15% for taxable gross. So while this is technically a 30% contribution rate, it only reduces your take home pay by 25%.
Last edited by Spirit Rider on Mon Aug 17, 2015 5:16 pm, edited 1 time in total.

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Re: Is Savings rate better calculated via Gross or Net?

Post by KlangFool » Mon Aug 17, 2015 1:09 pm

vitaflo wrote:
KlangFool wrote: Another vote for gross. Another advantage for gross is with this number, you can calculate expense easily...

Expense = Gross income - gross saving - tax
I do the opposite. Savings = Gross income - spending - tax

Basically, I use savings as "everything left over" after outflows from gross.

FWIW, I use net when calculating savings rate. Taxes are what they are, spending is variable and more under my control. I feel it gives me a better handle on my spending.
vitaflo,

<<Basically, I use savings as "everything left over" after outflows from gross.>>

That means you do not use "Pay Yourself First" saving method. If you do, the gross saving is fixed. You spend first and save later.

<< FWIW, I use net when calculating savings rate. Taxes are what they are, spending is variable and more under my control. I feel it gives me a better handle on my spending.>>

If you "pay yourself first", you save enough. Then, you can spend the rest. You do not need to have a handle on your spending. You cannot spend when you have no money.

KlangFool

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Re: Is Savings rate better calculated via Gross or Net?

Post by vitaflo » Mon Aug 17, 2015 5:38 pm

KlangFool wrote: That means you do not use "Pay Yourself First" saving method. If you do, the gross saving is fixed. You spend first and save later.

If you "pay yourself first", you save enough. Then, you can spend the rest. You do not need to have a handle on your spending. You cannot spend when you have no money.
I absolutely need to have a handle on my spending because my gross is not fixed. I own my own business and income is very different year to year. As such we have a budget we always stick to, mostly tied to what works in leaner years. So yes, I do not pay myself first, I stick to my budget and pay myself last.

When your income fluctuates up to 2x or 3x in any given year you tend to think of these things differently. Otherwise it's too easy to get yourself used to luxury when you can afford it and then get into trouble when you can't. Instead we target our budget to saving 15% in lean years, which means we can save up to 60% in good years, keeping the same standard of living. This prevents lifestyle creep.

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Re: Is Savings rate better calculated via Gross or Net?

Post by KlangFool » Mon Aug 17, 2015 5:59 pm

vitaflo wrote:
KlangFool wrote: That means you do not use "Pay Yourself First" saving method. If you do, the gross saving is fixed. You spend first and save later.

If you "pay yourself first", you save enough. Then, you can spend the rest. You do not need to have a handle on your spending. You cannot spend when you have no money.
I absolutely need to have a handle on my spending because my gross is not fixed. I own my own business and income is very different year to year. As such we have a budget we always stick to, mostly tied to what works in leaner years. So yes, I do not pay myself first, I stick to my budget and pay myself last.

When your income fluctuates up to 2x or 3x in any given year you tend to think of these things differently. Otherwise it's too easy to get yourself used to luxury when you can afford it and then get into trouble when you can't. Instead we target our budget to saving 15% in lean years, which means we can save up to 60% in good years, keeping the same standard of living. This prevents lifestyle creep.
vitaflo,

Thanks for the clarification. It helps to put things in context.

KlangFool

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