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Jan. 29, 2022, 9:17 a.m. EST

Is saving half your income hard? Saving 10% is even worse

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By Chris Mamula

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The alternative is relying on a paycheck into your 70s and government programs in retirement. That’s not easy either. Yet few people try to achieve financial independence because progress is so slow and the goal so far in the future when following standard advice.

That psychological reframe is powerful for many people. The upside of understanding the psychology of saving is that it can inspire action.

Regardless of how much motivation you have to save, we need to understand what actions to take that will actually move the needle.

The math of increasing your savings rate

First, you have to understand what savings rate is:

Savings rate = Savings/Income 

Stated another way:

Savings rate = (Income-Spending)/Income

Returning to our example household that is saving 10% of income:

Savings rate = ($10,000-$9,000)/$10,000 = $1,000/$10,000 = 10% 

There are two clear actions you can take to increase your savings rate. You can increase your income, keeping spending constant. You can decrease spending, keeping income constant. (A third option is to work on both components simultaneously.)

Read: I’ve set pay policies at big companies — here are 3 secrets to getting a raise

If you had to choose only one, it is faster and easier to increase your savings rate by decreasing spending. There are mathematical and tax reasons that make this true.

Using our example, decreasing spending by $4,000 a month looks like this:

Savings rate = ($10,000-$5,000)/$10,000 = $5,000/$10,000 = 50%

Using our example, increasing income by $4,000 looks like this:

Savings rate = ($14,000-$9,000)/$14,000 = $5,000/$14,000 = 36%

In either case, we increased our net savings by $4,000 and improved our savings rate. But when we decrease what our lifestyle costs, we simultaneously lower the bar for how much we need to save.

The math clearly shows that if your goal is to increase your savings rate, spending less is more impactful than earning more, all things equal. But all things are not equal.

Tax advantages of spending less

To this point, we’ve ignored taxes so as to keep the example simple. But in the real world taxes exist, and they provide extra incentive to be more frugal.

Assume our example household is in the 22% marginal tax bracket. If they want to increase their income by $4,000 a month, they would have to actually earn an extra $5,685 after accounting for federal income and payroll taxes. This doesn’t account for any state or local taxes they may also owe.

If they wanted to cut spending by $4,000, they would have to spend exactly $4,000 less.

This tax advantage alone is powerful if you’re looking to direct savings to debt payoff or building an emergency fund quickly. As you can start directing savings into tax-advantaged investments, you can further decrease your tax burden and accelerate reaching financial goals.

From Can I Retire Yet:  Early Retirement Tax Planning 101

The tactics of increasing your high savings rate

We now understand the psychology and math of savings, but we still need to understand the tactics. Once again, standard personal finance advice is failing most people.

There are endless articles about the “ latte factor ” and  cutting the cord . An entire reality series was dedicated to  extreme couponing . News stories frequently shame  the poor for buying lottery tickets  or  owning fancy cellphones .

Check out this chart from the  Department of Labor’s 2020 Consumer Expenditures Report .

Combined spending on housing and transportation represents at least 50% of average household spending across all demographic groups. Food accounts for at least another 10%. That’s over 60% of most household’s spending.

Focus on optimizing spending on housing, transportation and food first. Systematize and automate your finances so your money is going where you want it to go every month without applying effort or even thinking about it, and you are on the path to a high savings rate.

Taxes are not accounted for in the consumer expenditure report, but  they are a large expense that can be lessened with good planning . Once you have adequate savings and liquidity, you can start considering  self-insuring .

Reassess taxes and insurance needs once a year, automate actions, and forget about them for another year. These actions accelerate an already high savings rate with zero sacrifice (unless you enjoy paying taxes or insurance premiums).

The alternative is to buy into the narrative that saving requires sacrifice. Ignore the big-ticket items and instead focus on lattes, lottery tickets and your cable bill.

That advice is great for getting clicks to a website or starting arguments on social media. But it really doesn’t move the needle if we actually want to develop a high savings rate that can change your future.

Chris Mamula retired from a career as a physical therapist at age 41. This is an abridged version of his post “The Psychology of Saving Money” first published on the blog “Can I Retire Yet?

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