Your Personal Savings Rate

Your personal savings rate is simply the percentage of your income that you put away for long term savings. There may be some debate as to whether you should use your gross income (before taxes) or your net income (after taxes) when making the calculation. For example, someone earning $50,000 per year has a gross income of $50,000 and assuming roughly $10,000 in income taxes payable will have a take-home pay (or net income) of $40,000.

Again, your GROSS income is your income before income taxes and your NET income is your income after income taxes.

If this person was putting away $4,000/year for long term savings then their personal savings rate is either 8% or 10% depending on which number you use for your total income. Many people will use the rule of thumb that you should save 10% – they don’t really say of which number, but if you can manage it, try to aim for 10% of your gross income. For the example person above, this would mean saving $5,000 per year instead of $4,000.

10% is just a rule of thumb remember – if you can save more than that, even better. And no, it’s not easy. You may only be saving 5% right now, or perhaps even less. The average personal savings rate in the United States was negative in 2006. That means the average person spends more than they earn, which means they pile on more and more debt (or eat into savings or home equity).

As with many aspects of personal finance, this is mostly a psychological phenomenon. We have a tendency to spend what we earn, and most people will tell you that when they get their next raise, they will put it towards savings (or paying down debt), but in reality they have probably already decided what they will spend their raise on – which means they will never get ahead.

The personal savings rate used to be much higher but has steadily declined – due to easy access to credit, a lack of personal finance education in school and the glamourization by the media of spending excesses. If there is only one thing you need to do to be successful financially, it start with savings. Until you can get a handle on that, you don’t need to worry about investing (you’ll have nothing to invest).

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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  • Traciatim

    When Stats Canada does the savings rate, how do they come up with the figures? Are the savings rate calculated on income from say box 236 of the income tax forms after RRSPs are taken in to account, or before from line 150?

    For instance, my only savings right now are an RRSP. If the RRSP is counted as ‘savings’ then my savings rate is 12%. If the RRSP isn’t counted, I don’t really have any other savings (other than RESPs for the kids) so my savings rate is 0%.

    I wonder if the introduction of the TFSA will reverse this trend.

  • Preet

    @Traciatim – They only have tables for savings to RRSP and registered pension plans so the number is not truly reflective for those who choose to save through other vehicles. I didn’t comb through their site, but it looks like the only reference to savings for households are to registered assets. Further, the tables they have only reflect the numbers for those who save to an RRSP or pension, and doesn’t account for those who don’t save to these plans. So the “savings rate” for these tables is only for those who save. The average savings rate for all Canadians would obviously be less once those who don’t save are accounted for.

    I also saw that about 35-40% or so of Canadians in the labour force are part of a pension plan. In many cases this too would skew the number as I don’t believe all of those pension members would otherwise save on their own.

    And finally, with respect to the TFSA – I think it will pump up the numbers since it will be a registered account. As such the numbers have to be reported to the government. However, in terms of converting those who do not save at all into savers now, I wonder how much the taxation on savings is responsible for them not saving versus other factors (lack of planning, responsibility, etc). Surely, there will be some who divert extra dollars from low-interest debt repayment perhaps to TFSA savings, but then that raises a bit of a philosophical issue – do those who overcontribute to their mortgages count those overpayments as savings? Especially when they are planning on downsizing later and using the surplus for retirement spending (in part or in whole?).

    Clearly the issue of savings rates reporting is not very cut and dried! :)

    I am very curious to see how the TFSA will be received by the investing public. There are so many opportunities. I’m still waiting to hear about the washing of the income trail for the spousal spins we talked about before – the TFSA has yet to be finally approved as far as I know…

  • Michael James

    I agree with you about the importance of saving. For the first couple of years after graduating from university, my wife and I saved over 50% of our gross income. We just weren’t used to spending money.

    My two children have very different attitudes toward money. One is like my wife and I, and the other is more of a spender. I’d be interested in trying to learn more about the psychology of what makes people spenders and savers. I doubt that their approach to money has much to do with my attempts to teach them. I’d like to find some way to change my spending child’s habits.

  • Preet

    @Michael James – I’ll see if I can find some behavioural finance papers to blog about – I agree that this is very important, and probably much overlooked. Clearly the act of saving is a simple concept, so why is it so hard to do? Of course the billions of dollars on marketing efforts to get people to spend and finance those purchases is a big part, but there used to be a time when people were actually shunned for borrowing money to buy depreciating assets (and a time before that when a mortgage was considered less than socially acceptable).

  • Thicken My Wallet

    I would be interested to know savings rates based on demographics- do savings rates as a % of income go up or down during your life?

    TFSA- other than us geeky financial types, I am not sure how great of an impact this will have. The government has thrown everything and the kitchen sink to make RRSP’s attractive and people’s contribution rates are still quite low. If you have a savings rate close to zero or a negative savings rate, a fancy tax savings structure isn’t going to change your behavior (which is more influenced on impediments to consumption than tax-savings structures).

  • Preet

    @TMW – I haven’t seen the hard data, but I think it ramps up with age on average and peaks in the 40’s and 50’s (and 60’s). Part of this is due to the prime earning years being achieved, the mortgage paid off and the sudden realization that retirement is not that far off all of a sudden.

    TFSA – yup.

  • Traciatim

    TMW, and Preet. Are you sure about the TFSA? Everyone I’ve told at work (which is a contact center . . . so it’s not like we’re all investment bankers) about it is pretty interested in the TFSA and I’ve had to fight tooth and nail to get most of them to sign up with the 6% company matched RRSP plan. I hope I can get people on board with the TFSA when it launches. We have to let the government know with our dollars that we approve of plans like this.

    Of course, if it costs too much later I’m sure they will change the rules . . . just like always.

  • Preet

    Wait a sec – you had to convince them to take free money but they readily see the benefits of the TFSA? But aside from that, I think everyone will see the benefits when explained, but when it comes to going to set one up, I’m betting it’s put on the back burner for many. But good for you for being a market maven (see tomorrow’s post!) :)

  • Traciatim

    I’ve talked probably 10 people in to signing up to the RRSP plan. One of them said they would sign up long enough, but didn’t, that I physically went and got the forms and stood behind them while they filled them out, then walked them to the HR window to make sure they handed them in.

    Our RRSP plan is rather simple, it’s got 5 funds available to people, and 3 ‘life plan’ funds that are simply pre-configured combinations of the 5 funds. So it’s not like there is a pile of choices causing paralysis or anything.

    Anyway, of the people that I’ve told about the TFSA it’s been well received. I hope the people that are saying it sounds great actually use it.

  • Preet

    Keep up the great work Traciatim – I hope these people remember you fondly in the future. Now that it’s automatic for them they’ve probably adjusted just fine, but imagine where they would be 20 or 30 years from now without you – kudos.