To achieve financial independence, retire early (FIRE, Financial Independence, Retire Early), you need to know how to calculate your savings rate. The savings rate is a crucial metric in the FIRE movement, as it directly impacts the time it takes to reach financial independence.
Step 1: Calculate Your Income
To calculate your savings rate, you first need to determine your total income. This includes your salary, investments, and any side hustles. For example, if you earn $50,000 per year from your job and $10,000 from investments, your total income is $60,000. You can break it down as follows:
- Salary: $50,000 per year = $4,167 per month
- Investments: $10,000 per year = $833 per month
- Total income: $4,167 + $833 = $5,000 per month
Step 2: Calculate Your Savings
Next, you need to calculate how much you save each month. This includes money saved in a 401k, IRA, or other retirement accounts, as well as any cash savings. For instance, if you contribute $500 to your 401k and save $1,000 in cash each month, your total savings are $1,500.
Step 3: Calculate Your Savings Rate
Now that you have your income and savings, you can calculate your savings rate. This is done by dividing your savings by your income and multiplying by 100. Using the example above, if you save $1,500 per month and your income is $5,000 per month, your savings rate is:
(1,500 / 5,000) x 100 = 30%
The 25x rule (save 25 times your annual expenses) is a good benchmark to aim for when calculating your savings. For example, if your annual expenses are $40,000, you should aim to save $1,000,000 (25 x $40,000). The 4% rule (withdraw 4% of your portfolio per year, indexed to inflation) is a common guideline for sustainable withdrawals in retirement.
Moving the Levers
There are three main levers to move to increase your savings rate: increasing income, decreasing expenses, and optimizing investments. Here's an example of how moving these levers can impact your savings rate:
- Increase income: $5,000 per month to $6,000 per month = $1,000 per month increase
- Decrease expenses: $3,000 per month to $2,500 per month = $500 per month decrease
- Optimize investments: allocate $1,000 per month to tax-advantaged accounts, such as a 401k or IRA
By moving these levers, you can increase your savings rate from 30% to 45% or more. For example:
Original savings rate: ($1,500 / $5,000) x 100 = 30%
New savings rate: ($2,500 / $6,000) x 100 = 41.7%
For more information on how to calculate your retirement number and achieve financial independence, check out our post on how to calculate your retirement number and how much to save per month to retire early. You can use the Freedom Calculator to get a more accurate picture of your income and expenses.
New to FIRE? See our primer at https://freedomcalc.app/what-is-fire.
By following these steps and moving the three biggest levers, you can achieve a high savings rate and significantly reduce the time it takes to reach financial independence and retire early, with a clear understanding of your financial situation and a solid plan in place.
Tools worth looking at
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- Empower — Free net worth tracking, portfolio analysis, and retirement planner. The dashboard serious FIRE chasers actually use.
- Acorns — Round-ups that invest your spare change automatically. The lowest-friction way to start investing if you have been putting it off.
- Wealthfront — Tax-loss harvesting, a 5% cash account, and direct indexing once you cross $100k. Solid robo for the set-and-forget crowd.