With my colleague PK writing about his 2014 savings rate, I thought that I would chime in as well. Using a loose definition of savings, where principal pay down of debt is included in the numerator, I have an after-tax savings rate of 53.42%. Without including principal paydown of debt, my strict savings rate would be 31.76%.
A Note on Methodology
Savings Rate = (Total Savings) / (Post-tax Total Income)
Total Savings (for Me) = (Decrease in Debt Accounts) + (401k contributions) + (401k match) + (Roth IRA contribution) + (contributions to after-tax savings vehicles)
On total savings, the decrease in debt accounts is what is and is not included when you look at the difference between the two numbers. Total income is a little harder to calculate, and is where I imagine my numbers are vastly different from the rest of the internet’s:
Post-tax Total Income (for Me) = (Adjusted Gross Income) + (401k match) + (Pre-tax 401k Contributions) – (OASDI/Medicare Tax) – (State Income Tax) – (Federal Income Tax)
Progress Feels Slow
Many other sites float out strange numbers and call them “savings rates”.
After a long discussion, PK and I feel our methodology best calculates how well you put away money. Many numbers do not include pre-tax 401k contributions or the company match in the denominator (“Total Income”). Still others only look at cash-on-cash savings… if you, for example, take out $20k in debt but increase your savings from $1k to $21k, you have “saved” $20k. In my methodology (Total savings, not strict savings), that would mean you have saved $0.
The importance in writing this all out for me is that although I am making significant progress towards my goals, progress still feels slow. I started 2014 with about $4,000 in cash and I started 2015 with about the same amount in cash.
What is happening to all my money and why is my number still relatively high?
Well, debt paydown and retirement investment.
I maxed my 401k and Roth IRA last year and paid down about $24,000 in consumer debt (student loans and a small auto loan). That is where every extra penny of cash went to for both tax purposes (401k and Roth IRA) as well as future cash flow purposes (consumer debt). This exercise has underscored how the mentality of paying yourself first (by paying off debt and by investing in retirement vehicles) can lead you to keep the mentality that you are not making progress, thus limiting your spending.
The Importance of Debt Paydown in Savings Number
Last year, my goal was to get out of consumer debt (of about $38k) by the end of the year. Around mid-year, I shifted my target to max my 401k so I give myself a B- on that goal.
In any case, most of my after-tax cash savings went directly to reducing debt. If I didn’t include this in my savings, then I could just pump up my savings by holding onto it as cash and not putting it into debt. Conversely, accruing debt should count as negative savings, since it is an expense. If I add $5,000 in CC debt and increase my 401k by $5,000, I have effectively saved $0. I have only shifted my asset/liability allocation to higher leverage and to (probably) a negative future expectation of returns.