Savings Rate: The metric that fuels your journey to financial independence
Welcome to the third issue of Metrix that Matter, a weekly newsletter from WealthMetrix that helps you focus on what matters most for building and sustaining wealth. Every Saturday, we share an educational essay with actionable takeaways to guide you on your journey to financial independence.
School is out and the official start of summer is just around the corner.
If you’re like me, you planned a road trip with the family. You mapped out the destination, researched the best routes, made hotel reservations, and planned fun activities to keep everyone busy.
While all these plans are great, on the day of your trip, there’s one important thing you need to do first: fill up your gas tank. Otherwise, you’re not getting very far.
Just like any good road trip, your journey to financial independence also requires fuel. That fuel happens to be your savings. You can dream about your ideal life, make lavish plans, look for homes in places you always wanted to live, but none of that matters if you don’t have enough fuel to get you there.
What many people don’t realize until it’s too late is that the earlier you start filling up that tank, the less you’ll need to save along the way. Start saving at age 25 with steady contributions and watch how much faster your investments go into cruise control with compound interest. Wait until you’re 45 to get serious about saving and you’ll find yourself attempting to save as much as possible every year, desperately trying to get to the same destination in much less time.
Your journey to financial independence is the longest trip you’ll ever take. It’s filled with obstacles, roadblocks, and unexpected detours. The key is to keep providing fuel into vehicles that will get you where you want to go. Give yourself the ability to save and then consistently do it year after year for as long as you can.
The beginning of your trip
Your journey begins with a simple calculation, one that helps you determine how much fuel you are providing each year. That, of course, is calculating your savings rate, the percentage of income that you are actively contributing to savings and investment accounts.
As a refresher from last week, savings rate is calculated as shown below:
How much to save?
So, how much should you be saving of your income?
Your ideal rate depends on several factors: age, family situation, how much you’ve already saved, and financial goals, to name a few. But in general, there are some healthy ranges to strive for below:
For most families, I recommend at least a 10-20% savings rate. That is what I would consider a “healthy” range.
At 10%, you’re building a foundation that can start compounding towards your goals. At 20%, you’re accelerating your journey significantly. Below 10%, it becomes challenging to build meaningful wealth over time.
Where to save
Now that you have an idea of how much you should be saving, you need to direct those contributions into the appropriate accounts.
At the highest level, there are two main groups of accounts for you to direct your savings: liquid accounts and qualified accounts. In future issues, I will explain the two metrics on your Elements scorecard that measure these account types: Liquid Term and Qualified Term.
Today, all you need to know is that liquid accounts are accounts you can access at any time and for any reason, without penalty. Within this category, these are the accounts we look at:
Cash Accounts (Checking & Savings)
Non-Qualified Investment Accounts (Individual or joint accounts)
Qualified accounts are accounts with tax benefits. There are three main benefits for contributing to these accounts: you receive a tax deduction for contributions, you don’t pay tax on money that stays in the account, and/or you receive tax-free qualified withdrawals. While they can provide great tax benefits, these accounts have more restrictions than liquid accounts. You must meet certain requirements to contribute to and withdraw money from these accounts.
There are plenty of different account types within this category, but in general, qualified accounts have three purposes:
Retirement (Traditional or Roth 401(k), 403(b), 457(b), IRA)
Education (529 Plan)
Healthcare (HSA)
Since you may have a need to save for all these purposes, naturally, the next question becomes: how do you allocate your savings between the accounts? How do you prioritize competing goals, such as retirement and education?
How to split the pie
While there’s no one-size-fits-all formula, liquid cash and retirement accounts consistently emerge as the top two priorities across the clients I serve. What does that mean in practice? Here’s a basic framework to get you started:
Start with your safety net
Cash levels are often neglected, but they're crucial for managing unforeseen risks and expenses. Without adequate cash reserves, you're one emergency away from derailing your entire financial plan. You might be tempted to maximize retirement contributions right away, but don't do it at the expense of having a critical cash cushion.
Then focus on retirement
This is likely the largest goal you'll ever fund in your lifetime. It takes decades of consistent saving to build enough assets to sustain 20-30 years of retirement. Make this a priority and make sure to take full advantage of any available employer matching contributions.
What about other goals?
Once you have six months’ worth of spending available in cash and you're saving at least 10% for retirement, you can layer in other priorities. College savings, taxable investments for additional liquidity and flexibility, or accelerating your path to financial independence with higher savings rates.
Most importantly, start somewhere, even if it's not perfect. You can always redirect your savings as your situation and priorities change.
Ways to improve
Maybe your savings rate isn’t quite where you want it to be. How do you improve?
You need to have the proper systems in place. As author James Clear explains in Atomic Habits, “Goals are about the results you want to achieve. Systems are about the processes that lead to those results.”
The most powerful systems are the ones that require the least amount of effort from you to maintain, the ones that don’t rely on sheer willpower. Motivation comes and goes.
If you have access to an employer retirement plan, you may also have access to a couple systems that could benefit you greatly: automatic enrollment and automatic escalation.
Automatic enrollment is a feature that enrolls you in your retirement plan as soon as you are eligible. There is a default contribution percentage, and a default investment election built into many plans. Automatic escalation increases your contribution percentage by 1% per year until you reach a maximum set limit.
Without requiring any effort on your part, these two systems allow you to save for retirement and increase your savings rate every year. If you get an annual raise, you probably won’t even notice the automatic increase in savings.
If you don’t have access to an employer retirement plan, you can still set up systems of your own with automatic recurring contributions into accounts that you establish. Either way, the key is to automate your contributions as much as possible. Require as little effort as possible. Set up the proper systems on the front end, so that month after month, the transfers happen automatically. Month after month, direct money into your accounts, regardless of what’s happening in the stock market.
Putting it all together
Your savings rate is the single most powerful metric you control on your journey to financial independence. Unlike investment returns, which are unpredictable, you can improve your savings rate starting today.
Wealth isn't built by timing the market or finding the perfect investment. It's built by consistently fueling your journey, month after month, year after year. A mediocre investment strategy with a 20% savings rate will beat a brilliant investment strategy with a 5% savings rate almost every time.
The beauty of focusing on savings rate is its simplicity. While others obsess over market predictions and hot stock tips, you can quietly build wealth by automating contributions into the right accounts with a disciplined investment strategy.
Next week, we'll explore the flip side of savings: your Burn Rate (spending). Every percentage point you reduce unnecessary spending is a percentage point you can redirect to savings. They're two sides of the same coin, locked in the financial physics of equal and opposite reactions that we discussed in the last issue. This metric also has a direct impact on each of the other 10 on your scorecard.
WHAT TO FOCUS ON THIS WEEK
Calculate your Savings Rate. Add up all monthly or annual savings going into liquid and qualified accounts. Then breakdown where your contributions are going within each category. You can do this with a notepad, Excel spreadsheet, or by using the tool I use, Elements (invite below).
Identify one specific action you could take to improve your Savings Rate by 1%.
Can you set up automatic contributions?
Are you enrolled in your employer’s retirement plan?
Are you taking full advantage of all employer matching contributions?
Are you participating in automatic annual savings increases through your plan?
ELEMENTS INVITATION
Thank you for reading. At the end of each newsletter, there is an invite to use Elements to see your financial metrics. If you are ready to gain more clarity into your financial situation, we invite you to click the link below to get started with Elements. You will be asked basic financial questions about income, spending, debt, and account values. The process takes about 10 minutes. Once complete, we will review your metrics and send you an email to schedule a 30-minute phone call to discuss your situation, answer any questions you have, and see if there’s a potential fit to work together. This whole process is complimentary.
SEE YOUR FINANCIAL SCORECARD IN 10 MINUTES
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