We have talked a lot about expenses already and defined the neat KPI L12M_avg_exp. Now we want to go a step further and compare our income and our expenses. To do this, we have to understand income. So what is income? Income is all the money that you get/receive on your bank account on a certain month. For most people the income is governed by the income from their day job.
So let us say that your job pays you 2000 EUR a month. This is not what your work contract says but the real money that arrives in your bank account, after all taxes are taken away. This also ignores payments to health insurance and pension that are mandatory. Using this approach of just looking at money that you really get on your bank account and not some numbers that you anyway cannot control is key to becoming a financial unicorn. Because everything that goes directly to some governed institution that can freely choose if or when they will pay your pension is not something that you should count on. Today the government says that you can go into pension with 67 year. In 10 years they might say, “hey, now everybody can only go into pension when they are above 80 years old”.
So now let us calculate your savings rate.
To do this you simply can divide your income minus your expenses (which is the money that you save every month) by your income.
Income from your day-to-day job for last month: 2000 EUR
Expenses of last month: 1000 EUR
So your savings rate would be (2000 EUR – 1000 EUR) / 2000 EUR = 0.5
And if you prefer percentages then you can transfer the savings rate to a savings percentage by multiplying the rate with the value 100. So in the example above your savings rate would be 50%.
But let us do another example. In this case your income is not only coming from your monthly job income of again 2000 EUR but you also got dividends of 100 EUR in the month that you are looking at. So now you can again calculate your savings rate which is (2000 EUR + 100 EUR – 1000 EUR) / 2000 EUR = 0.55 or in as percentage 55%. Note that the denominator is defined by the income from your job and not by dividend income. So once, in this example, your dividend income reaches 1000 EUR, you reach a savings rate of 1.0, which means you save 100% of the income from your job because all your expenses are already covered by dividend income.
Savings rate between 0 and 0.1 – it is a start
Savings rate between 0.1 and 0.5 – savings rate of most people and households that save some money.
Savings rate between 0.5 and 1 – you save more than you spend and might at some point be able to live from your savings
Savings rate above 1 – you could now live from your dividend income alone
Using the savings rate, you can understand how much money you save every month. Obviously, you can also create the savings rate for the L12M like the L12M_avg_exp KPI by using values for the rolling last 12 months. So you just add up your income of the last 12 months minus the added up expenses of the last 12 months and divided it all by your income of the last 12 months. What you now end up with is your average savings rate of the last 12 months that we call L12M_avg_savingsrate. As with the expenses, it is totally acceptable to just use the data you have in the beginning and expand this calculation once you have more months of data. But always use a 12 months time-frame so that you omit seasonal effects in your statistics.
The L12M_avg_savingsrate is a really nice KPI that you can use to understand if you are living adequately according to your income and expenses relationship. It is also far more reliable than just looking at your savings rate of the last month. In the future, we will investigate this KPI a lot more and it is a key method to understand your financial situation that is really easy to calculate.