The Sane Path To Achieving A High Savings Rate

It’s been a long week. I wanted to get this post about achieving a high savings rate out on Wednesday, but I had a lot going on both at work and at home. There are a lot of moving parts in my life right now! Holiday season, amiright? Plus, I kept adding more and more to it. There are so many ways to go when talking about savings rates!

So unfortunately, I didn’t get this out on my normal schedule. I think it actually works out, though, because this topic lends itself well to a Finance Friday. So here you go – a surprise Finance Friday post! You’re welcome.

Achieving A High Savings Rate – It’s Just That Easy!

Have you ever seen one of those articles that talks about saving half your income, and they make it seem like it’s something you can just ease into in a few weeks? An article like this one?

Yeah. It’s not that easy.

If you are incredibly motivated and already have a lot of ridiculous spending in your budget and are a high earner, sure, maybe you can go from a 0% savings rate to 50% in 3 months. But something tells me that’s not typical of most people. There is a way for people to incrementally increase their savings over time, though, even if they are starting at 0%. For most of us, it’s going to take a bit longer than a few weeks or months, but it can be done.

That’s what I want to talk about today. Consider this a “How To Achieve A High Savings Rate Without A Total Life Overhaul” guide. I’m going to teach you the method I used to create a high savings rate.

I have a pretty high savings rate. To the “average American,” (I kinda hate that term, but it’s sometimes helpful) it’s probably really high. To the FIRE community, it’s probably pretty average. But I didn’t get there overnight. It’s taken nearly ten years of incremental increases. And I’m paid pretty well. My salary is not the average American salary. So I’m going to use a detailed real-world example of how somebody with a pretty normal salary could do it.

These methods don’t include massive reductions in spending or job changes. They really don’t include any change at all, actually. Just simple steps that everybody…okay, most people…can take to improve their savings rate over time.

Why discuss this now? Because January 1st is rapidly approaching. At the end of the post, I’ve got a challenge for you. If you’re ready to increase your savings rate, join in!

Savings Rate and Retirement

I’ve talked before about how if you keep your expenses low, you don’t need as much money to retire. That’s because if you limit lifestyle inflation, retirement can be funded with a smaller amount of money.

But just how much money do you need to retire? Luckily, one of the seminal pieces of work in the FIRE community answers exactly that question. Check out the Shockingly Simple Math Behind Early Retirement for details.

Not into early retirement? Don’t worry, it covers how much you need to save for many career lengths.

Now, as with most things in life it’s not actually quite that simple. There are a lot of factors that go into achieving enough to retire, such as the rate of return, sequence of returns, your withdrawal rate, taxes, etc. But the Mr. Money Mustache article should be enough to demonstrate to you that a higher savings rate is better.

My Savings Rate

Right now, I have a 40% savings rate. It varies sometimes, because I tweak my budget as needed to make sure I’m maximizing my savings. For instance, a few months ago I was up to 43%. In January, I think it’ll be around 42% (military basic pay and BAH (housing allowance) raises pending approval). Maybe I’ll provide you an update once my new budget (with new apartment!) is complete.

That savings rate is based on my gross (pre-tax) total military paycheck (basic pay, BAH, and BAS (subsistence allowance)). While I know some (possibly many) military members don’t include their BAH and BAS in their income calculations, I think that is weird and misleading. If you want an accurate picture of your income (and savings rate), you gotta include those things.

Also, I’m only including long-term savings in there – investment savings. I don’t include shorter term savings for things like cars, or vacations, or other large purchases.

My net (after-tax) savings rate is 47%, and I think it will get to 50% in January. Mr. Money Mustache uses net income in his Shockingly Simple Math post. I like to use gross because I know how much gross income I have each month – I won’t know my net income until I file my taxes the following year.

I do not include any income from my taxable account dividends because that money is automatically reinvested – so in my head it is neither income nor an investment. It’s completely transparent to me. A gift from the dividend gods.

And I don’t include the profit from my rental property because I currently keep all of that money separate. It gets deposited into a separate savings account and the expenses are withdrawn from that separate account.

How I Got To My High Savings Rate

I didn’t go from 0% savings to 40% overnight. While some articles might make it sound like “it’s just that easy”, I think most of us realize it’s not. Here’s how I actually did it.

My budget records go back to August 2007 (don’t you judge me for keeping my records that long!). At that time I was still paying off the last of my debt, so the only savings I had were a Roth IRA and my emergency fund. However, because my income was comparatively low at that point, those two things made my total savings rate almost 11%. Not shabby at all, and right about in line with conventional wisdom at the time.

In June 2008, I promoted to a new rank. That new rank, with the associated bump in basic pay and BAH, meant I was earning 18.8% more than I was previously.

Holy cow. I’ve never done that math before. That is a huge jump in pay!!!!

I decided to put 100% of that money (plus a bit of other money) into my investments. Here’s what that looks like:

Aug 2007:

• Income: $4,922
• Savings/Investments: $538
• Gross savings rate: 10.93%

Jun 2008:

• Income: $5,848
• Savings/Investments: $1,519
• Gross savings rate: 25.97%

You can see how putting the entire pay raise into savings and investments caused a huge jump in my savings rate. And at the time, that was very possible for me because I had stabilized my spending and didn’t need to spend the money on anything else. However, I know that’s not always possible…and it’s not what I’ve done since then.

Since 2008, I have instead pledged to save at least half of all raises. That has allowed me to incrementally increase my savings rate while also giving me money to deal with monetary inflation, some controlled lifestyle inflation, and the effects of moving to cities that have different costs of living (military life!).

By saving at least half of all raises, I know that my savings rate will increase over time. But because they are raises, I don’t really feel any negative effect on my wallet. I still get to increase my spending somewhat, but my savings will increase by more. That’s pretty cool.

If that doesn’t work for you, another method is to save/invest promotion pay increases, but keep the increases for longevity and cost-of-living increases.

Here is a little deeper explanation of what I’m saying.

Method #1: Save 50% of all raises

This one is easiest to understand and implement. Any time your pay goes up, for whatever reason, save at least 50% of it. If your pay increases $10/week, set up an auto transfer from your checking account to your savings account of $5. If your pay increases $500/month, that sounds like a great amount to open up an investment account and designate $250/month to it.

Of course, you can go higher than 50%. Save 60%, or 75%, or even 90%. But you do want to give yourself a little bit of money sometimes to account for monetary inflation. And lifestyle inflation isn’t a terrible thing so long as it is controlled thoughtfully.

But if you possibly can, I recommend 50% as the minimum amount you set aside. If you do that, you will always be increasing your savings more than you increase your spending. That’s the way to achieve a long term savings rate increase.

Method #2: Save certain types of raises

The other option is to pledge to yourself to save 100% of certain types of pay increases, while allowing others to provide you more spending money.

There are a few different types of raises people get. In the military, we get raises for promotions, longevity, and each January 1st you can expect some additional money (between the basic pay, BAH, and BAS, often all 3!) for cost-of-living adjustments.

From what I can tell, it’s basically the same in the civilian world. The only major difference I see is that in the civilian world, you can get an entirely new job and have an accompanying change in pay. Sometimes the pay change is a small raise, sometimes it’s a big one, and sometimes you take a pay cut. In the military, salaries aren’t tied to specific jobs that way. But regardless, pretty much everybody is familiar with those three main types of raises – promotions, longevity (annual raises), and cost-of-living increases.

Personally, if I was going to implement this method, I would save/invest all promotion raises and allow the longevity and cost-of-living increases to raise my spending to account for monetary and lifestyle inflation. That is, after all, exactly what they are designed to do. This method allows you to keep a relatively steady spending on lifestyle, with only moderate upgrades, while dramatically increasing your savings rate.

The downside to this method is that promotions usually don’t happen all that often. It might be several years between promotions, whereas your longevity and cost-of-living increases will happen every year or two – sometimes even more often. So you end up making huge changes when you get a promotion, but stagnating in the in-between years.

Method #3: Combination for the hardcore savers

If you really want to increase your savings rate rapidly, you can always combine the methods. For instance, save 100% of all promotion money and 50% of longevity and cost-of-living increases. That would supercharge your savings – again, without making you cut anything out. Pretty nice, right?

The upside is obviously the supercharged savings rate. The downside is that you aren’t giving yourself much money to reward yourself for all of your hard work. Some people can do this for years – most of us can’t. It would be pretty austere after awhile.

Now let’s see what some of this would look like in the real world.

Let’s see this in action

For my example, I’m going to use an E-5 in the military who is starting from a savings rate of 0%. Why? Because this is the perfect example of a pretty typical American income, moderate raises, and how to make method #1 work. You can insert your own historical income and raises to see how it would have worked for you.

Let’s call this E-5 Sam. Sam is an E-5 (Staff Sergeant) in the Air Force in 2007. He has been in the military for 5.5 years at that point and is 25 years old. For simplicity’s sake, Sam is going to stay single and live alone throughout this scenario.

On December 31st, 2006, his basic pay + BAH + BAS totaled $3143.86 ($2124.60 + $747.00 + $272.26). That’s an annual 2006 income of $37,726.32. According to the US Census Bureau, the median household income was $48,451, so we can see Sam is about 22% below the median at the start of this scenario.

On January 1st, 2007 he realized he needed to start saving some money, so he decided to start putting 50% of the annual cost-of-living increase he just received into a savings account. After that, he realized it was going pretty well, so when he received a longevity increase at his 6-year point that July, he put 50% of that away, too.

After he saw how quickly his savings rate was going up, he decided to commit to savings 50% of all pay increases from now on. Let’s see where he stands a decade later.

Civilian readers: since I’m doing an example of an enlisted military member, I’ll be talking about multiple types of income that form the overall paycheck. Don’t worry about that. Just look at the overall number if that makes the most sense for you.

PS: I’m going cross-eyed looking at these numbers! I think I’ve got them all correct now, but if not – the intent is still the same and the method works as described!

January 2007 Savings Rate

As of January 1st, Sam’s monthly income increased to $3212.88 ($2171.40 base + $762.00 BAH + $279.88 BAS) through a cost-of-living increase. That’s a difference of $69.02 each month. He decides to put 50% into an emergency fund, so he has $34.51 pulled automatically from his checking account and sent into a savings account. His January 2007 gross savings rate is 1.1%.

July 2007 Savings Rate

On July 1st, Sam reaches 6 years of service and gets a longevity pay increase. His new income is $3365.68 ($2323.80 + $762.00 + $279.88); the pay increase is $152.80. He sends half of that ($76.40) into savings along with the $34.51 he was already saving, for a total monthly savings of $110.91. His July 2007 gross savings rate is 3.3%.

January 2008 Savings Rate

On January 1st, 2008, Sam receives another cost-of-living increase, so now his income is $3506.98  ($2405.10 + $822.00 + $279.88). His monthly pay increase is $141.30; 50% of that is $70.65. He starts sending that money along with the previous $110.91 to savings for a total monthly savings of $181.56. His January 2008 gross savings rate is 5.2%.

January 2009 Savings Rate

On January 1st, 2009, Sam receives another cost-of-living increase, so now his income is $3705.87 ($2499.00 + $883.00 + $323.87). His monthly pay increase is $198.89; 50% of that is $99.45. He starts sending that money along with the previous $181.56 to savings for a total monthly savings of $281.01. His January 2008 gross savings rate is 7.6%.

July 2009 Savings Rate

On July 1st, Sam reaches 8 years of service and gets a longevity pay increase. His new income is $3877.77 ($2670.90 + $883.00 + $323.87); the pay increase is $171.90. He sends half of that ($85.95) into savings along with the $281.01 he was already saving, for a total monthly savings of $366.96. His July 2009 gross savings rate is 9.5%.

January 2010 Savings Rate

In January, Sam not only gets the annual cost-of-living increase; he also PCSes to MacDill AFB in Tampa. We’re going to assume his new BAH is needed entirely for his new place upon move-in, so any change there won’t be counted towards his new savings.

His new income is $4333.67 ($2761.80 + $1248.00 + $323.87). The increase of only his base pay + BAS (not counting his BAH) is $90.90. He combines half of that ($45.45) with the $366.96 he was already saving and – since he already has a good emergency fund built up from the last three years of saving – starts investing it in the TSP or an IRA (doesn’t matter) for a total monthly contribution of $412.41. His new gross savings rate is still 9.5%.

January 2011 Savings Rate

In January 2011, Sam gets another cost-of-living increase. His new income is $4373.54 ($2800.50 + $1248.00 + $325.04); the pay increase is $39.87. He combines half of that ($19.94) with the $412.41 he is sending to his investment account for a new monthly total of $432.35. His January 2011 gross savings rate is 9.9%.

By the way – if you are checking my math and see that the Tampa BAH for an E-5 without dependents is actually $1182/mo in 2011 you are correct. However, on the rare occasion that BAH is lowered in an area, people who are already earning the higher rate will continue to receive the higher rate as long they don’t change rank or with/without dependent status. This happened to me in 2011, too. It was caused by the recession and BAH finally colliding.

July 2011 Savings Rate

On July 1st, Sam reaches 10 years of service and gets a longevity pay increase. His new income is $4520.54 ($2947.50 + $1248.00 + $325.04); the pay increase is $147.00. He sends half of that ($73.50) into his retirement account(s) along with the $432.35 he was already saving, for a total monthly investment of $505.85. His July 2011 gross savings rate is 11.2%.

From 0% to over 11% in 4.5 years! While still being able to increase his lifestyle!

January 2012 Savings Rate

In January 2012, Sam gets another cost-of-living pay increase. His new income is $4591.04 ($2994.60 + $1248.00 + $348.44); the pay increase is $70.50. He sends half of that ($35.25) into his retirement account(s) along with the $505.85 he was already saving, for a total monthly investment of $541.10. His new gross savings rate is 11.8%.

August 2012 Savings Rate

On August 1st, Sam is promoted to E-6! And gets the accompanying pay increase. His new income is $4923.74 ($3243.30 + $1332.00 + $348.44); the pay increase is $332.70! Half of that is $166.35, which he combines with the $541.10 he was already investing, for a total monthly savings of $707.45. His August 2012 gross savings rate is 14.4%.

January 2013 Savings Rate

In January 2013, Sam again receives a cost-of-living pay increase. Regular as clockwork, those are. His new income is $4982.77 ($3298.50 + $1332.00 + $352.27); the pay increase is $59.03. He sends half of that ($29.52) into his retirement account(s) along with the $707.45 he was already saving, for a total monthly investment of $736.97. His new gross savings rate is 14.8%.

July 2013 Savings Rate

On July 1st, Sam reaches 12 years of service and gets a longevity pay increase. His new income is $5179.57 ($3495.30 + $1332.00 + $352.27); the pay increase is $196.80. He sends half of that ($98.40) into his retirement account(s) along with the $736.97 he was already investing, for a total monthly savings of $835.37. His July 2013 gross savings rate is 16.1%.

January 2014 Savings Rate

In January 2014, Sam gets the annual cost-of-living increase plus he PCSes to Buckley AFB in Denver, Again, we’re going to assume his new BAH is needed entirely for his new place upon move-in, so any change there won’t be counted towards his new savings.

His new income is $5255.95 ($3530.40 + $1368.00 + $357.55). The increase of only his base pay + BAS (not counting his BAH) is $40.38. He combines half of that ($20.19) with the $835.37 he was already saving and sends it to his retirement account(s) for a total monthly contribution of $855.56. His new gross savings rate is 16.3%.

January 2015 Savings Rate

In January 2015, Sam gets his normal cost-of-living pay increase. The new total is $5394.72 ($3565.80 + $1461.00 + $367.92). The pay increase is $138.77. He sends half of that ($69.39) to his retirement account along with the $855.56 he is already sending, for a new total of $924.95. His January 2015 gross savings rate is 17.1%.

July 2015 Savings Rate

On July 1st, Sam reaches 14 years of service and gets a longevity pay increase. His new income is $5456.22 ($3627.30 + $1461.00 + $367.92); the pay increase is $61.50. He sends half of that ($30.75) into savings/investments along with the $924.95 he was already saving, for a total monthly savings of $955.70. His July 2015 gross savings rate is 17.5%.

January 2016 Savings Rate

In January 2016, Sam gets another cost-of-living pay increase. The new total is $5689.99 ($3674.70 + $1647.00 + $368.29). The pay increase is $233.77. He sends half of that ($116.89) to his retirement account(s) along with the $955.70 he is already sending, for a new total of $1072.59. His January 2016 gross savings rate is 18.9%.

Within 9 years he is saving over $1000 per month!

January 2017 Savings Rate

In January 2017, Sam again receives a cost-of-living pay increase. His new income is $5853.79 ($3751.50 + $1734.00 + $368.29); the pay increase is $163.80. He sends half of that ($81.90) into his retirement account(s) along with the $1072.59 he was already saving, for a total monthly investment of $1154.49. His new gross savings rate is 19.7%.

July 2017 Savings Rate

On July 1st, Sam reaches 16 years of service and gets a longevity pay increase. And he also promotes to E-7. Nice.

His new income is $6604.09 ($4387.80 + $1848.00 + $368.29); the pay increase is an enormous $750.30! He sends half of that ($375.15) into savings along with the $1154.49 he was already saving, for a total monthly savings of $1529.64. His July 2017 gross savings rate is 23.2%!

What Else Sam Could Do To Supercharge His Savings Rate

In 10.5 years, fictional Sam went from a 0% savings rate to an 23.2% savings rate, with no noticeable effect on his wallet. That’s pretty impressive. According to this report from the Bureau of Economic Analysis, the average American’s savings rate has been about 4% in 2017. Sam is almost six times the average with no effort! And while still giving himself plenty of money to keep up with monetary inflation and some sensible lifestyle inflation too.

However, if he really wanted to supercharge his savings, he could have done a few other things. For instance, if he had saved 100% of his promotion pay increases when he tacked on E-6 and E-7 instead of “just” 50%, he’d be saving another $442.50 each month. That would be a total monthly savings/investing of $1972.14 and a savings rate of 29.9%.

So… doable, but with very little extra money in your pocket over all those years of hard work. It’s up to you whether that’s worth it.

Or he could save 60% of all raises…or 70%…or whatever amount makes sense to him.

Personally? While I’ve pledged to save “at least” 50% of all raises, it often works out to more. I automatically mentally set aside 50% of my raises. Then I look at what that leaves and where I might need to apply a little bit of money to my budget to keep the lifestyle I want. If, for instance, my overall raise is $100, I’ll mentally tell myself I have $50 to play with. If I want to add $5/month to my gift category, $15/month to transportation , and $15/month to “miscellaneous,” that’s only $35. I would have $15 leftover that would get sent back to my savings/investing money. I’d end up saving $65 out of the $100 raise, or 65% of the raise. Make sense?

You Can Still Use Other Methods

Of course, all of this can be combined with the normal recommended methods. Stop buying things you don’t need, and put that money into savings (hello, Starbucks). Buy a smaller house and a used car; put the money you aren’t paying for a higher mortgage and car payment into your retirement account. Give up the magazine and gym subscriptions. Learn to cook better food at home so you don’t spend as much at restaurants.

All of those are good ideas, but they require lifestyle changes that you may not be willing or able to make. So if you can’t, or won’t, do all of those things, using one of the three methods of setting aside money from your pay increases will still get you to a high savings rate eventually. It may not happen as fast, but it will happen.

Challenge!

It’s the time of year when we start hearing about new year bonuses and raises. For military members, we are still waiting to hear what our pay raise and BAH increases will be. The two numbers floating out there for the base pay increase are 2.1% and 2.4%. For BAH and BAS – who knows???

For my civilian readers, you may or may not be expecting a raise on January 1st. If you are, feel free to join in!

I challenge everybody who is expecting a raise on January 1st to mentally set aside at least 50% of that money as soon as you know how much it is. By mid-December, go into whatever banking or investment platforms you use and set up an automatic withdrawal so that amount is immediately diverted from either your paycheck or your checking account into a savings or investment account. This way the money will be out of your reach as quickly as possible. If you never see it, you’ll never miss it!

Then let me know how it goes next year and cheer on the others! You can “like” me on Facebook at the Military Dollar page to talk about it!

What is your current savings rate? What do you want it to be?