Savings Rate vs. Spending Rate?

If you read the Financial Independence (or FIRE) blogs, you will see a lot of talk about your Savings Rate.  There are some fantastic posts that tell you how quickly you can retire if you only have a specific Savings Rate (see here for example).  The theory is that the higher your Savings Rate, as a percentage, the lower your cost of living is in comparison to your income and the quicker you achieve a level of savings that will generate enough income from being invested in the stock market that you can retire and live off your nest-egg and the income it produces.  There are lots of calculations on how this works and I recommend reading around the topic.  This article is not going into any of that detail... but I do want to talk about your Savings Rate.  It is such an important feature in the Financial Independence community but I think it needs to be looked at differently when you are coming at this from the perspective of someone in debt (like me!).

When you are paying off debt, you might think your Savings Rate is going to be negligible, that you cannot save anything because you are fully committed to paying off debt with every last penny you earn.  That's great!  But you shouldn't be discouraged for a couple of reasons:

1.  First, the money you are currently paying towards debts is the equivalent of what you will be able to save once you clear all of the debt if your income and lifestyle remain the same.  So if you currently spend 30% of your net income on debt repayments, once you are debt free you will be able to save 30% of your net income and have a 30% Savings Rate.  You can then plug that figure into a calculator like the one in this article I mentioned above and work out how long it will take you to retire and be fully financially independent (28 years based on a 30% Savings Rate).   That might give you some encouragement (it might not!).  Of course, you need to start your countdown to financial independence from when you reach the zero point on your consumer debt and can start actually investing that 30% of your income but at least you know how far you have to go once you are debt free, based on your current level of spending on debt payments.  Essentially, your debt payments are the equivalent to your future savings.  You should feel good about how much you are able to put aside each month for that.

2.  The inverse of that is to look instead of your Savings Rate at your Spending Rate, i.e. what percentage of your income do you spend to live.  In the example above, excluding debt payments, if you spent everything else on your ordinary living expenses, you would have a Spending Rate of 70%.  One good thing about being in debt, once you have kicked the habit of spending more than you make and incurring further debt (and I mean when you are fully into the debt repayment zone) it teaches you to live on less than you earn.  In this example, you are living on 70% of your net income, because you are spending the other 30% on debt repayment.  You become accustomed to living more frugally because you have to.  The money you need to allocate to paying debt monthly payments does not feel like your own income, so you do not treat it is though it was yours.  Then, when you clear those debts, you can continue living as you did with your 70% Spending Rate.  Look at the table in the article by Mr Money Mustache above and just minus the number for the Savings Rate from 100 to get the Spending Rate.  For example, a Savings Rate of 40% of your income, would give you a Spending Rate of 60%.  Based on your current debt payments, if you are living on 60% on your income, once you clear that debt you could be fully financially independent in 22 years.  This is the same whatever your income level, because your lifestyle expenses adjust to fit the maths.


                                        


Have a go at working out your own Spending Rate now.  An example, based loosely on my own figures, would be as follows:

 - Net Income - £4,000 per month
- Monthly living expenses - £3,000 per month
 - Debt payments - say £1000 per month including amounts I overpay currently as well as just the minimum payments (excluding mortgages)

Giving me a Spending Rate of 75% if everything after debt payments is spent on living costs.  If I continued like that after I cleared my debts, it would take me a further 32 years to be financially independent... not really the goal I am shooting for here!  Of course, that doesn't take into account my wife's income and you can do the same calculations for joint incomes and expenses if you want to.

So I have three options to improve my score of 32 years from when I become debt free.  I can either increase my income and keep my living costs the same, or I can reduce my living costs and keep my income the same, or some combination of the two.  Finding an extra 15% in my monthly budget, from either additional income or savings made in my living costs would give me a 60% Spending Rate and (assuming I invested the 40% difference) would knock 10 YEARS off my journey to financial independence, down to 22 years.  The maths of that would look like this:

- Net income - £5,000
- Monthly living expenses - £2,000
- Savings - £3,000

So in the above example to get from a 75% Spending Rate to a 60% Spending Rate I had to increase my income by £1,000 per month and reduce my expenses by £1,000 per month. That is separate from the debt payments, which were outside the living expenses.  At least it gives you some numbers to play around with to help you create a goal to work towards.  Remember, things always progress more quickly than you think once you get started!

Looking at the idea of Savings Rate in the context above has helped me to not feel like I am banging my head against the wall financially, or that I am too far behind the game to ever get ahead and become financially independent.  That's not the case.  It is never too late and I hope you will join me on the road to financial independence... See you at the finish line!