﷽
Today, we wanted to talk about a very important topic that you will need to master on your road to financial freedom. This is the all important SAVINGS RATE. Understanding your savings rate is critical to financial planning, budgeting and figuring out where and how much you are able to invest for your future. If you do not have a high-enough savings rate, it doesn’t matter how much you make because you are spending all of your money just living. Getting a handle on your savings rate can be the difference between retiring early, or delaying your retirement YEARS, even if you are making a high salary in relation to where you are living. The goal is to maximize your highest income earning years by saving as much money as you can.
So what exactly is a SAVINGS RATE? 
Your savings rate if calculated by figuring out how much money you are taking home and subtracting the amount you are spending (to support your lifestyle); and monitoring how you are doing as a percentage of your income. Seems basic right? It absolutely is!
The equation looks like this: (Take home pay – spending) / (take home pay) , then multiply by 100 to get a percentage.
Let us create a hypothetical example to illustrate this concept.
Muhammad is 26 and has begun his career as a newly graduated structural engineer working for a corporation. He currently lives at home with his parents, has a used car that is paid off and does not have any real debt outside of a $18,000 student loan that he will need to begin paying off now that he’s working. He is in an entry level position making $68,000 / year, which translates to about $50,000 dollars after taxes. This leaves him with roughly $4166 / month in earnings.
Muhammad’s take home pay: $50,000 / year or $4166 / month
Now let’s take a look at Muhammad’s spending. He has had some financial literacy and Islamic training and has avoided riba (usury / interest) where he could, but he was unable to avoid getting a student loan to complete his university education. He likes to hang out with his friends from university, and helps out with bills and things for his parents from time-to-time.
His spending:
- Loan amount – $18,000 at 3.95% interest across 120 months (10 years): $ 227.53 / month
- Car insurance – $120 / month
- Car gas – $150 / month
- Cell phone – $70 / month
- Internet and Netflix – $70 / month
- Helping out with parent’s bills – $400 / month
- Food and eating out – $500 / month
- Entertainment – $380 / month
- Clothing – $230 / month
- Gym membership – $30 / month
- Haircuts – $40 / month
- Miscellaneous Expenses – $100 / month
Muhammad’s total spending: $ 27,810.36 / year or $2317.53 / month
So now looking at the savings rate formula, this will give Muhammad his maximum percentage that he should be able to save and invest with this current spending and income.
($50,000 – $27,810.36) / ($50,000) * 100 = 44.4 %
44.4% is an excellent savings rate for Muhammad to use for savings and investments. Realistically, Muhammad would probably leave some room in there, so 30 – 40% savings rate is still quite good for someone starting out in their career. Compare this with the average savings rate in America which is 5.7% (https://www.fool.com/saving/2016/10/03/heres-the-average-americans-savings-rate.aspx), Muhammad is off to a good start. Most financial experts and advisors recommend a minimum of 10 – 15 % savings rate just to ensure that you can continue to provide in the case of emergency, job loss and general life events.
I hope going over some basics of financial literacy was beneficial for my readers. We will continue to explore these topics and get into more complex ones as we move along.
Please comment if you found it insightful or if you have any thoughts on the topic!
Until next time.
Assalamu-Alaykum