A lot of people have trouble calculating their savings rate. It sounds simple – how much are you saving each month? But, it quickly gets complicated when you start introducing taxes, withholding rates, retirement account contributions, retirement account matches and other perks. Oh, and what do you do with your student loan or mortgage payments? Do those count as savings?

## Step-by-step of how I calculate our savings rate

Each month I calculate our savings rate as follows:

**Income**. How much money did we make this month? I’m counting our top-level income before anything, including taxes, is taken out of our paychecks. It includes perks like if your firm covers your mobile phone expenses. If I had a 401(k) match, I’d also add it to the income column. This is the denominator.

**Savings in Taxable Accounts**. Contributions to a taxable account are perhaps the easiest contributions to count as savings. If we contribute any money to a taxable savings or investment account, I include the contributed amount as a line item in the savings column. In other words, if you put $1,000 in a savings account marked “House Fund,” then you count $1,000 saved. If I withdraw money from one of those accounts to cover some “unexpected” expense, then I enter a negative amount saved for that line item.

**Savings in Retirement Accounts**. Any money that we contribute to retirement accounts (e.g., 401(k), IRA, HSA, etc.) get counted as savings without regard to the future tax implications. This means the numbers are a little misleading. When you make a pre-tax contribution to a retirement account, you’re opening up two accounts – one of which belongs to you and another which is a side account that belongs to the government. Unfortunately, it’s impossible to predict the size of the government account because you don’t know how much of that investment you will ultimately pay in taxes. Either way, it’s reasonable to expect that the government’s share won’t be zero and so if I wanted to be closer to reality I should discount each contribution to a retirement account by some future marginal tax rate that I expect will apply to withdrawals. Rather than engaging in something this complicated, I choose to count 100% of retirement accounts as dollars saved. Perhaps I’m just optimistic in thinking that I’ll find ways to withdraw that money completely tax-free in the future. Either way, that’s how I do it.

**Student Loan Payments**. When I had student loans, I counted 100% of the payments toward the student loans as savings. My rationale is that this is money that you would otherwise be saving in a taxable account if you weren’t making the student loan payments. In other words, you may have a negative net worth, but each student loan payment brings you closer to “net worth zero” and therefore should count as savings. However, you shouldn’t spend too much time patting yourself on the back for student loan payments because in reality they represent repayment of previous consumption choices (i.e., your decision to obtain a law degree). Student loan payments won’t lead to a comfortable retirement on their own, so it’s best to get those student loans paid off as soon as possible so you can start to build real wealth.

**Mortgage Payments**. There’s a lot of debate about whether mortgage payments count as part of your savings rate. I don’t have a mortgage, so this is a theoretical argument for me. However, if I did have a mortgage, I would count the principal payments as part of my savings rate. The principal represents money that you can access in the future upon a sale of the house (one would hope). I would not include the payments toward interest, as that represents a consumption expense related to borrowing the money to purchase the house.

**Things That Don’t Count**. Here are a few things that don’t count toward your savings rate that I see people sneak in from time to time:

*Investment Gains*. That’s great that your investment performed well this month and the market is up. Those gains show up as an increase in your monthly net worth calculation. But, those gains could be easily erased next month. What you can’t do is count those gains toward your savings rate. Once you accumulate more than six figures of assets, it gets easy to focus on your monthly change in net worth and mistakenly think you’re doing a much better job than you are if all you’re tracking is that monthly net worth gain. Instead, focus on brute savings and let the market take care of itself.

*House Appreciation*. Along the same lines, occasionally people will fixate on the value of their house and track each month’s latest Zestimate or other approximation for home value. I’d steer clear of doing this in the first place and only update the market value of my house once a year at the most. But, regardless of how often you’re trying to track this number, any increase or decrease has no business in your savings rate. Like investment gains, the value of your house is only relevant for the calculation of your net worth.

## Taxes

Now that we have a working definition of income and savings, you’d think we’d be done. Just divide your savings by your income, and you’ll have your savings rate. Unfortunately, there are two camps when it comes to calculating your savings rate: net and gross. In the net camp, taxes are simply read out of the calculation. The argument goes that taxes have to be paid regardless, so the actual savings rate you’re looking for is how much is saved of your after-tax income. On the gross side, people view taxes as just one of several expenses. Taxes may be mandatory expenses, but they’re still *expenses*, and they should be counted in the calculation of your savings rate.

I calculate both my gross and net savings rate so I have them handy in case I’m ever involved in a discussion about savings rates. However, I think calculating your **gross savings rate** is the best indicator of your savings.

Why should you focus on your gross savings rate rather than your net savings rate?

It’s a defeatist attitude to argue that taxes are merely required spending and can’t be adjusted. In fact, there’s a lot that you can do to legally reduce your tax burden, like taking advantage of pre-tax retirement contributions and maximizing deductions/credits. By including taxes as an expense, I motivate myself to both increase brute savings and reduce taxes wherever possible, since a decrease in my tax burden results in an increase in my savings rate.

To set up a quasi-accurate monthly approximation of your taxes, I take last year’s federal, state and local tax bill plus FICA taxes and divide the result by 12. The resulting calculation is my monthly estimate for my tax bill.

The calculation of your **monthly gross savings rate** is Amount Saved / Gross Income.

The calculation of your **monthly net savings rate** is Amount Saved / (Gross Income – (Taxes Paid Last Year / 12)).

## The most important metric of all

However you calculate your savings rate, the most critical consideration is whether it’s adequate for your financial goals. Your savings rate is so much more important than your rate of return, particularly during the early years of paying off debt and accumulating assets. If you focus on boosting your savings rate, you’ll see great progress toward your financial goals.

Joshua Holt is a former private equity M&A lawyer and the creator of Biglaw Investor. Josh couldn’t find a place where lawyers were talking about money, so he created it himself. He spends 10 minutes a month on Empower keeping track of his money and is always negotiating better student loan refinancing bonuses for readers of the site.

I also include house payments for the same reasons you mentioned. It can be converted to cash if needed. Every one has slightly different ways of calculating savings rate. The key is keeping our calculations consistent over the months and years so we are comparing like for like and can see real progress. There is no point calculating savings rate post tax income one year and pre tax income the next. It is false progress.

Good point about consistency. You’re not doing yourself any favors if you switch up the way you calculate it!

Seems you calculate exactly as I do, and with the same logic. It’s almost as if we share a common background of some kind…

It seems to me that the rationale for counting principal payments as savings but excluding interest payments should apply equally to mortgages and student loan payments. In both cases, principal payments increase your net worth while the interest payments are merely the “cost” of previous consumption. Any reason you recommend counting the whole student loan payment toward savings rate, but excluding the interest on mortgage payments?