Part 1 of 3-Part Series
And so, we come to perhaps the most discussed topic in personal finance and maybe finance overall, saving! We’ll explore the savings ratio which is included in our list of vital personal wealth ratios, but we’ll also explore why some save more than others. It seems like a straightforward topic, but there are a lot of factors you might not normally think about when discussing savings.
Right off the bat, let’s see the formula for the Savings Ratio or SR. It’s a very simple relationship in which you divide your annual savings by your annual personal income which gives the SR or percentage of savings.
Total Personal Income would constitute your entire income from all income streams for the year, but not including any investments unless they were made liquid in that year. It would also be after taxes as it’s calculating based on income actually received. Annual savings is the money you put away from that income and the rest it is assumed is spent on basic necessities and luxuries. The SR will always be a number between 0 and 1 because it is impossible to save more money than you earned, and this converts to the savings percentage over the year.
We’ll use a very simple example to illustrate this. If you earned $150,000 over the year and you were left with $110,000 after taxes, this is your total personal income. Over the year you spent $75,000 in mortgages, house expenses, food, vacations, and anything else you needed or wanted. That leaves you with $35,000 in annual savings because you did not spend it. Annual savings as shown is your total income minus expenditures over the year. Your SR works out to $35,000/$110,000 which is a very healthy 0.32 or 32%.
Part 2 continued next week.