How to fake your Savings Rate with Math
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You probably all know what a savings rate is. It is merely the percentage of your income that you are saving. If you do not know your personal savings rate, you should probably start by calculating it.
The basic formula is relatively simple. You need to divide your savings by your income. And this gives you your savings rate. It seems simple, right?
Unfortunately, it is not that simple. There are many ways to calculate it. The problem comes from what you count as expenses and income. And because of that, it is challenging to compare savings rates.
And it seems that most people on the internet are trying to inflate their savings rate by using computation that yields a higher number. So today, we will see how to increase your savings rate with math!
In this article, I will show how we increased our savings by 26% without doing anything! And so can you!
Savings rate and math
The formula for savings rate is pretty simple: Savings Rate = (Income – Expenses) / Income = Savings / Income.
Based on that formula, there are two ways to increase your savings rate:
- You increase your savings.
- You decrease your income.
The second part is counter-intuitive. But a smaller income makes it easier to have a high savings rate. If two families can each save 5000 CHF each month, but one family has an income of 10’000 and the other of 20’000, the first one has a much better savings rate!
Before we play it, we should see what is the savings rate. It is how much percentage of your income you can save. To optimize it, you will increase your savings either by increasing your income or decreasing your expense.
Your savings rate represents your capability to save. Therefore, the savings rate should only take into account things that you can control and should ignore the rest.
Now, many people will not agree with me, especially bloggers. Indeed, a lot of people just want the higher number possible, regardless of whether it makes sense or not. Some people do that for their ego, and others for their audience. In both cases, I think this does a disservice to everybody!
Use your net income (fair)
The first way is to use your net income instead of your gross income. I am not talking about the taxes you pay each year. I am talking about the direct deductions that are made on your income. For instance, in Switzerland, disability insurance is directly removed from our salary. In the United States, your 401(K) contribution is also directly withdrawn from your salary.
How much of a difference do you think it makes?
If you have a gross income of 10’000, a net income of 9000, and expenses of 5000, you can save 4000 per month. If you compute your savings rate based on your gross income, you will get 40% (4000/10000). But if you use your net income, it becomes 44% (4000/9000)!
Congratulations, you just increased your savings rate by 10% with math!
I think this is a very fair way of computing your savings. You have no opportunity of reducing this difference between your gross and your net income. So you should not count it as expenses!
Use your post-taxes income (unfair)
We try yet another way to improve our savings rate with math. Some people like to consider their post-taxes income instead of considering taxes as expenses.
For instance, your net income is 9000, and you have 5000 monthly expenses. Now, 1000 of these expenses are for taxes. Whether you remove your taxes from your salary or add it to your expenses, your savings are the same. Here is how we could use this to our advantage:
- Pre-Tax Income Savings rate of 44% (4000/9000)
- Post-Tax Income Savings rate of 50% (4000/8000)
Once again, we can increase our savings by 6% with some math!
Now, I do not think this is fair to compute it like this. Some people would argue that taxes are not under our control, and so should not be considered in your savings rate. I would argue precisely the contrary!
Taxes are under your control. By earning more money, you are increasing your taxes. Moreover, there are ways to optimize your taxes. For instance, you can invest in tax-efficient funds. And you could also move to a country with lower taxes. These changes are all under your control.
Add your retirement contributions as savings (meh)
Another way to increase your saving rate with math is to consider your retirement contributions as savings. For instance, if you pay 5% of your salary every month to your 401(K) or your second pillar, you can consider this as savings.
We can take an example again.
You have a gross income of 10’000, a net income of 9000, and 5000 of expenses. But 5% of your gross salary goes towards your retirement account. If you do not consider them, you will have a savings rate of 44% (4000/9000). If you consider them, you get 50% as a result!
Once again, congratulations, you just added 6% to your savings rate by doing nothing!
I think this is already borderline unfair. You do not have control of this contribution. As such, you do not have the opportunity to save it. You are forced to save it. For me, this is not the proper usage of the savings rate.
On the other hand, if you can choose this contribution, it could make sense to consider it. But for instance, if the minimum is 5% and you are contributing 7%, you should only take 2% into account. Since this is the only thing you control.
Add your employer contributions as savings (unfair)
But we can do even better! Most employers match some contributions to the retirement account. So we could also count it as savings.
You have a gross income of 10’000, a net income of 9000, and 5000 of expenses. Again, 5% of your gross salary goes into your retirement account. And your employer is matching this 5%. We now take the three cases:
- Base: 44% savings rate (4000/9000)
- Your contribution into savings: 50% savings rate (4500/9000)
- Your employer contribution into savings: 55% savings rate (5000/9000)
Adding your employer contribution adds 5% again to your savings rate!
Now, I think this one is unfair to count as savings rate, for two reasons. First, you do not have the choice to save this money! You did not do anything for it, and you just increased your savings rate. It feels like cheating to me.
And the second reason, using this, you could have a savings rate higher than 100%! It would mean you save more money than you earn. It is plain stupid, which shows that this does not make sense!
Remove Expense X from your income (stupid)
Finally, here is the last way to optimize your savings rate! Some people remove some expenses, other than taxes, from their income instead of adding them to their expenses. Removing an expense from your income has the same effect as taking the post-tax income.
We take our example again, a net income of 9000 and expenses of 5000. For instance, you want to remove your health insurance from your income instead of adding it to your expenses:
- Net-Savings Rate: 44% (4000/9000)
- Net-Savings Rate without expense: 47% (4000/8500)
Congratulations, you are saving 3% more per month!
This last one just does not make sense. I have seen this done several times on the internet, making my skin crawl. I have seen one example where people did that for a so-called mandatory expense, such as health insurance in Switzerland.
For me, this is a just way some people use to inflate their savings rate for showing off. There is no reason to remove an expense from your income. Even for taxes, it made little sense, but for any other expense, it is just stupid.
Once again, some people would say they have no control over that, but they do! Even if health insurance in Switzerland is mandatory, you still have some control over how much you pay.
Putting it all together
We can put everything together with a final example.
Once again, the gross income is 10’000, and the net income is 9’000. Your retirement contribution is 5%, and your employer contribution is 5%. 1000 CHF of your 5000 CHF monthly expenses is for taxes. Each month you spend 500 on your health insurance.
Here are all the levels of savings rates:
- Gross Savings Rate: 40% (4000/10000)
- Net Savings Rate: 44% (4000/9000)
- Post-Tax Savings Rate: 50% (4000/8000)
- Post-Tax Savings Rate with Employee Contribution: 56.25% (4500/8000)
- Post-Tax Savings Rate with Employee/Employer Contribution: 62.5% (5000/8000)
- Post-Tax Savings Rate with Employee/Employer Contribution Without Health Insurance: 66.6% (5000/7500)
Congratulations, your savings rate went from 40% to 66.6%! You are now in the elite savers! And you did not need to save any extra money to increase your savings rate!
I hope this shows that this way of counting your savings does not make sense!
We increased our savings rate by 26%!
Finally, we see how to increase our savings rate with some math!
Our gross income is about 10’400 CHF, and our net income is about 9’400 CHF. 4% of our gross income goes towards our second pillar, and my employer matches this 4%. Generally, we spend around 5000 CHF per month. Of this, about 900 CHF goes to taxes, and 800 CHF goes to our health insurance.
- Gross Savings Rate: 42.3% (4400/10400)
- Net Savings Rate: 46.8% (4400/9400)
- Post-Tax Savings Rate: 51.7% (4400/8500)
- Post-Tax Savings Rate with Employee Contribution: 56.6% (4816/8500)
- Post-Tax Savings Rate with Employee/Employer Contribution: 61.5% (5232 / 8500)
- Post-Tax Savings Rate with Employee/Employer Contribution Without Health Insurance: 67.9% (5232/7700)
Wow! Our savings rate increased from 42% to 68%! Does this mean 50% more savings no? Will we be able to retire earlier? No! We are not saving anything more. We just inflated our savings rate with math!
It does not make sense!
Conclusion
I think that is enough math and manipulation for one post! As you can see, there are many ways to manipulate an important metric, such as the savings rate. It is essential to know these tricks to realize what a savings rate may mean.
You should not always trust savings rates online. By default, you should not compare savings rates. People may compute it differently. Unless you know exactly how someone calculates his savings rate, you cannot compare it. By default, you should only consider your own savings rate and not consider others’ results.
And guess which savings rate a dishonest online influencer will choose to shine? He will choose the highest one, regardless of how unfair it is! So if you compare your fair savings rate with his unreasonable savings rate, the comparison does not make sense!
Also, I am not trying to encourage you to cheat! On the contrary! I think everybody should use the same formula. The net savings rate is the best way to compute this critical metric!
Removing things from your expenses just does not make sense. It increases your savings rate, nothing more. And it makes you complacent since you think, wrongly, that you are saving more!
I wish bloggers would use a fair way to compute their savings rate instead of just trying to aim for the highest number for no reason. Or, at the very least, they should indicate exactly how they compute it before publishing it. It shows once again that we are having a transparency issue on the personal finance community.
The savings rate is a very important metric because it is the only metric that matters for your path to Financial Independence. Your savings rate will tell you how many years you have to retire.
If you are interested in metrics, there are many more personal finance metrics.
What do you think? How do you compute your savings rate? What do you think is the fairest way to calculate it?
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Hi Baptiste, very interesting post, as usual :-)
I also live in Switzerland (in Gland, VD), and – similarly to you – I’m trying to save as much as I can to reach FIRE asap. However, I have a doubt: I know that some countries (e.g. Italy) are checking the families’ saving rates, and if they are “too high compared to the average” the Tax Department can assume the presence of earnings not declared, with consequent fines and different problems.
Since I’m extremely frugal, I have a very high saving rate, and I’m wondering if this could trigger the Swiss Tax Offices: do you have any comment, or experience, about that?
Many thanks,
Alex
hi Alex
This is a rare case, but it indeed happens. I have heard one person saying that the tax office thought he was hiding money because it did not spend enough. I don’t know how it was resolved. But I would not worry too much about that as long as you are honest and not trying to hide anything. It may trigger an audit but if you are honest, you should be able to go through unscathed.
I have only heard of one case and I know many very frugal people, so this may be a big exception.
Many thanks for your quick response, it’s very appreciated! :-)
Do you calculate the paying off the principal of your home loan as savings?
Hi Kara,
I don’t count it as an expense, which does indeed increase my savings rate. Amortization is a zero-sum move, it moves cash to real estate.
Hi TPS,
I have a couple of comments on this topic:
1. You are suggesting that by lowering your income the savings rate goes up. That however is based on the assumption that the expenses will be decreasing more (proportionally) than the decrease in income. And I don’t think that’s a fair assumption to make. Savings rate is always dependent on both income and expenses.
2. I have a completely different view on the concept of savings: to me, relevant metric (since we are talking FI and FIRE) is how the monthly / annual savings (and not the savings rate) compare to FI (savings rate calculated as savings / FI). If our goal is to achieve FI, savings rate as suggested in this post doesn’t help much, unless there is a very close correlation between income and FI. Based on savings, FI and an assumption on how our investments will perform over the next several years we can calculate the time needed to reach FI. For me, savings rate is purely for bragging purposes, regardless how it is calculated.
I hope this makes sense.
Best,
Adrian.
Hi,
Keep in mind that I am suggesting ideas to make your savings rate higher with math, not good ways to increase your savings rate. This not advice to save more, just advice against comparing saving rate with people that are just trying to show off with their savings rate.
1. If you are removing X CHF from your income and X CHF from your expenses, your savings rate will go down, this is just math, not anything else.
2. If you compute your savings rate as savings on income, it definitely helps for your time to retirement. It’s true that this is only the case if you compute it properly. But the savings rate is important for your retirement: https://thepoorswiss.com/years-until-you-can-retire/
Hi there, I’m wondering how you would treat the case of voluntary pre-tax pension contributions.
When I was trying to put my own numbers together, I stumbled over this line item and was not sure how to handle it.
Here’s a summary:
I am voluntarily contributing to a pension account from my pre-tax salary. I could choose to contribute nothing, so that’s why I consider this an (active) act of saving. There is a limit up to which I can contribute, but I can choose any amount between zero and the limit. I also get a % employer contribution on whatever amount I chose, so again, I have some influence on this amount. Therefore, I also currently this as a saving.
How I currently treat this is as follows:
I account for the entire amount (my contribution + employer contributation) as both as (net) INCOME and as SAVING.
Do you feel that that is fair? Would you suggest to handle it differently?
What I’m currently doing seemed like the fairest way I could come up with, but I’m very open to suggestions!
Thanks in advance for any thoughts :)
Hi LadyFIRE,
If you consider yourself that it’s fair, it’s often good enough :)
I think it’s okay to consider your contribution to the pension fund since you can choose what to do with it. You could spend and you do not, so it makes sense to include it in yours savings.
Personally, I think it does not make to include your employer contribution in it since you could not spend it. Now, it’s not particularly unfair either :)
Personally, I also contribute each month some part of my salary to our pension and this is matched by my employer, but I have no control over it and I do not include it in our income.
Thanks, that’s a fair point about not being to choose spending the employer contribution.
The only other thing I could think of would be treating the employer contribution like an automatically reinvested dividend payment. In the way that I’m accounting, it would then neither be part of the INCOME nor the SAVINGS portion, but would be reflected in the net worth growth.
I’ll think about changing this, thanks for your thoughts!
Really interesting (and frightening!) to see the different ways you can calculate such a basic metric. I’m just starting out my FIRE journey. After having calculated my net worth, the savings rate is next. Intuitively, I would have used my after-tax income because that’s what hits my checking account every months (as a foreigner my employer automatically withholds taxes for me). However, given the wide range of income tax rates across cantons, it really does make sense to count taxes as expense. Otherwise, if I choose to do some geo arbitrage and move to Schwytz, this won’t even be represented in my savings rate. That would be a shame ;)
Hi Thomas,
This should not frighten you :) At least, it was not my goal.
The main point is that you cannot compare savings rates with other people. It is important that you choose the savings rate formula that works well for you. But do not compare with other people since different people will use different formula. And many online people will use the formula that yields the highest number (because big numbers sell better).
In your case, I would also use the after-tax income since that’s what you get in your bank account. And once you switch to paying taxes directly, you can adapt. But if you want, you can consider the before-tax income and then add your taxes as expenses as well. And then, geo-arbitrage would be represented in your savings rate :)
Thanks for stopping by!
Interesting article.
I also live in Switzerland and I would calculate my savings rate based on my net income (after taxes as per the definition of net income = disposable income). The range of motion for reducing taxes is quite limited and paying them is mandatory. For me, they are not expenses in the classical sense. And the vast majority probably wouldn’t move to a different country just for saving taxes (at least I hope so).
As for mandatory health insurance, I view it differently since I would have it even if it wasn’t mandatory, which is why I see it as an expense.
What you consider the “fairest” calculation would automatically give everyone living in a high-tax country a massive disadvantage when comparing savings rate. Example: Germany has an income tax of up to 42%. This means that even someone who had 0 expenses, would never be able to get a savings rate higher than 58%.
If you calculate the savings rate on net income (as per the definition of net income), it is much more comparable since it is aimed at evaluating how much spending you can actually cut from your everyday life.
All the other points you make with artificially inflating your savings rate are absolutely fair and nonsense if someone does it this way :)
As mentioned above, I strictly calculate my savings rate on net income (after taxes, other deductions and even the 2. pillar contribution) since that money was never “available” to me to make an active choice whether I want to spend it or not.
Calculating 2. and 3. pillar contributions as expenses, as some other readers have done, is cheating yourself the other way for me: decreasing the savings rate even though the money is not “spent = gone”. You put it from an accessible account into a less accessible account but it is still yours meaning it has not been spent. On the saving rate spreadsheet, it shouldn’t even show up.
Hi Lutze,
I understand your point of view regarding taxes even if I do not agree :)
And it’s true that most people would not move just for this! For instance, taxes can be changed based on how you amortize. There are some decisions that will impact taxes. And for me, this should be reflected in the savings rate as well.
I still think that’s it’s fairer because it takes countries into account. If you want to be able to compare properly two people living in different countries, you have to take taxes into account.
But in the end, the savings rate is a personal thing. As long as you do not compare your savings to other people that do not use the same computation, this is perfectly fine. For instance, your savings rate will likely be higher than mine if you compare it like that and we are equally frugal.
Thanks for sharing :)
Just to make sure you did not read too fast, I consider EXTRA second pilar contributions (buy-in only) as expenses ;-)
Yes, that’s what I got :)
Counting mandatory second pillar contributions as an expense out of the post-tax income would not make much sense!
But for me, it’s still more of an investment than an expense.
But everybody should choose a personal savings rate!
I also believe savings rate are flawed and we comparé apples with pears: for instance I give much more credit to a low income earner anywhere in the world than a high earner in Switzerland. To make a fair assessment kids shall also be considered, especially in Switzerland.
As an employee, my fair way to calculate the savings rate is based on my after-tax income (8000 CHF in your example), BUT considering extra second pilar and 3rd pilar contributions as expenses, as they are not (very) liquid and as I use these contributions to decrease my tax
Hi Judit,
This is very true! Even inside a country, there are some large differences. We should actually normalize the savings rate by the income to have something of a norm at least inside a country.
Wow, I don’t know anybody who is considering second and 3rd pillar as expenses. But it kind of makes sense since as you said, they will also decrease your taxes. It kind of balances the fact that you are using post-tax income :)
Thanks for sharing!
Good post ! This applies to comparing taxes between countries also.
For example, in Nordics, we pay high taxes for our wages, but we don’t need a health-insurance or a college-fund for our kids. Schools and healthcare are free.
That’s a very good example :)
If you remove your health insurance in Switzerland where it’s expensive, you will be ahead of a country where it’s included in taxes!
I really wish people would stop inflating numbers just for show!
Thanks for stopping by!
P.S. The search on your website does not work from posts but it works from the index.