Two birds sitting in a tree
Photo by SK Yeong

The current savings rate in the United States is 3.4%

For every $100, the average American spends $96.60 and saves only $3.40.

This is absolutely BONKERS.

Yet it seems that whenever we talk about building wealth, we only talk about how to make MORE money.

With a savings rate of 3.4% it doesn’t matter how much we make.

It’s like trying to fill up a glass with a huge hole on the bottom. No matter how much water we pour in, the water level will never increase.

The determining factor in how quickly you’ll build long-term wealth is how much you SAVE, not how much you MAKE.

The power of increasing your savings rate

Let’s take a peek into the life of Emma Bigsaver. 

Emma has just graduated from college and found a job paying $10,000 per year. She’s incredibly frugal and manages to save 90% of her income.

In her first year, she makes $10,000 and saves $9,000. 

$10,000 * .9 = $9000

Her net worth is now $9,000.

Net worth at the end of year 1
End of year 1

In her second year, she again makes $10,000 and saves $9,000.

Her net worth is now $18,540.

Wait…am I assuming she lost a tooth and the tooth fairy gave her an incredibly generous $540 for it?

Nope. There’s no tooth fairy magic needed to build long-term wealth.

Two walruses laying on a beach
I feel sorry for the Walrus Tooth Fairy. Talk about a thankless job. Photo by Jay Ruzesky

Emma, that cunning saver, invested the $9,000 she saved in the first year and this money grew at (a realistic) 6%, turning those initial $9,000 into $9,540.

$9,000 * .06 = $540

The $9,000 saved during the second year plus the $9,540 already saved takes her net worth to $18,540.

Net worth at the end of year 2
End of year 2

In her third year, she again makes $10,000 and saves $9,000.

Her net worth is now $28,652. 

Welcome to the wonderful world of compounding. The more money you have, the faster it grows.

$18,540 * .06 = $1,112 and $18,540 + $1,112 +$9,000 = $28,652

Net worth at the end of year 3
End of year 3

At this point, 5.7% of Emma’s net worth is “free” money (money that came from investment gains). That’s pretty incredible.

$28,652 — $9,000 —$ 9,000 — $9,000 = $1,652 and $1,652/$28,652 = 5.7%

Money made from investment gains
Free money!

How a high savings rate allows you to reach financial independence

At the end of the third year, Emma decides to take a leave from her job and during the next year, she splurges.

She does some traveling, some partying, and ends up spending $1,500 (considering that she was spending only $1,000 during the previous years, this is a substantial increase.)

At the end of the year, Emma realizes how much she has spent and freaks out.

Yet when she went to look at her investment account, she saw her net worth had grown to $28,871.54!

She spent way more than she usually does and her net worth still increased by $219!

What is this black magic?!

The $28,652 she had invested during the previous three years continued to grow at 6%, yielding $1,719 during year four.

$28,652 * .06 = $1,719

Net worth at the end of year 4
End of year 4

From these $1,719 of investment gains, Emma spent only $1,500, so her net worth continued to grow.

When your annual investment gains are greater than your expenses, you’re financially independent.

Without realizing it, Emma reached financial independence.

When investment gains are greater than expenses you've reached financial independence.
Investment gains are greater than expenses. Financial independence!

The effect of savings rate on years to financial independence

Emma was able to reach financial independence in just three years due to her incredible 90% savings rate.

This, of course, isn’t a realistic savings rate.

But you might be surprised to find that with a 50% savings rate you would be financially independent in only 17 years (as compared to the usual 40–50 year slog).

Check this out:

Effect of savings rate on years to retirement
Chart courtesy of Mr. Money Mustache

The takeaway from this should be that you must KNOW and TRACK your savings rate.

Savings rate = take home pay — expenses

The point of tracking it is to keep yourself accountable, not to compare against anyone else.

Have you ever noticed that anybody driving slower than you is an idiot, and anyone going faster than you is a maniac?  — George Carlin

Knowing how DEEPLY your savings rate impacts the time to reach financial independence helps make clear the value of every dollar and the consequences of mindless spending.

If you want to see the effect of different savings rates on the time to financial independence, Networthify has a nifty little calculator.

It will take 68.4 years to reach financial independence with a savings rate of 3.4%
You’ll never be financially independent with the average savings rate. Screenshot from Networthify.

It’s not about money, it’s about happiness

It’s easy to lose the forest for the trees.

Money itself has no value. There’s no use in collecting it.

Money is only in valuable in terms of what it can do for us.

A nicer car would do nothing for me. Eating out every day does nothing for me. An expensive new watch does nothing for me.

This is all very personal.

The important thing is to be aware of what each dollar really represents and to decide accordingly on how we want to spend it.

I always need less than I think do.

My family, my friends, a warm shower, a comfortable bed, a good book, a tasty meal, new sights.

It’s not about the money, it’s about happiness.