Optimizing Your Savings Rate for Financial Freedom
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Disclaimer: I am not a financial adviser, and this content is for informational and educational purposes only. Please consult a qualified financial adviser for personalized advice tailored to your situation.
Track and Manage Your Expenses Effectively with This Free Excel Tool
Our personal finance blog aims to improve financial literacy and guide you on your journey to achieving financial independence. To achieve financial independence, you need to maximize your savings and strategically invest them to grow your wealth, so you can eventually live off those investments without being dependent on employment. For most, this occurs at the traditional retirement age, where a person exiting the workforce is able to live off a combination of pensions, savings, and investments. However, for those who plan ahead this can be achieved much sooner.
In this post we will outline a simple approach that you can use for tracking your expenses and give you ideas on how to optimize your savings rate, the single most important factor for reaching financial independence.
How to Increase Your Savings Rate for Financial Independence
You can’t manage what you can’t measure. It is not much of an understatement to say that it will be nearly impossible for you to reach financial independence if you don’t have a good understanding of what you are spending your money on. I know many high earners that are really terrible at tracking their expenses and have only a very vague idea of what their savings rate is.
The problem is that, at the end of the day, the savings rate is a critical ingredient for reaching financial success. It is important to understand that someone with a very high income but low savings rate will take longer to reach financial independence than someone with a modest salary but implementing an aggressive savings rate. If this concept is not clear to you, I’d encourage you to play around with different levels of income, expenses, and savings rates with this online calculator before continuing further.
Start by Calculating and Tracking Your Savings Rate
The first step to optimizing your savings rate is to calculate it and to track it over the long term. In one of our previous posts, we provided examples on how to easily calculate your savings rate to monitor your financial progress. It is essentially your net savings divided by your net income (i.e., after taxes). If your net monthly income is €2,500 and you spend €2,000, then your savings rate is 20%–you are saving a fifth of your after tax take home pay.
You can increase your savings rate in two effective ways to reach financial independence faster, either by increasing your income (while keeping your monthly expenses constant) or by reducing your monthly expenses. Today’s post will focus on the latter strategy, which for most cases will be the easier approach to start out with.
Building the habit of tracking your monthly expenses is crucial for long-term financial success. For some, this may seem like a tedious exercise to engage in, but–trust me–building this new muscle is the small price to pay for unlocking a lot more freedom in your life. In principle, you can choose any medium you’d like to record your expenses on. For many people, using a simple Excel budget sheet is the best way to track expenses effectively, since you will be able to store the information and compare the data easily across months.
Photo by Eneko Uruñuela on Unsplash.
I’ve taken a budget template provided by Microsoft Excel and have adapted it to our purpose: 1) to track expenses, 2) to optimize savings rate, 3) to your track path to financial independence. You can download it for free here. On the first tab (“Sept2023”) you can see an example has been filled in for illustration purposes. It is very straightforward: in the budget template, fill in columns B-C with all your household income to get a clear picture of your finances, while in columns E-H you can enter all of your expenses.
As observed, the savings rate figure on the top left has full prominence. This is intentional–it is because this is by far, again, the most important factor that needs to be optimized as you track your progress over the months ahead. Tracking every single expense helps you make smarter financial decisions to optimize your savings, i.e., figure out what you can cut out. Remember the 3 step framework discussed in the previous post.
Cut Recurrent Expenses to Boost Your Savings
For most, it helps to start out by focusing on your recurrent expenses. I’d recommend a two step approach here. Step one is to identify and eliminate unnecessary expenses from your budget to maximize your savings rate–do you really need four entertainment tv/series subscriptions? What about the magazine subscriptions you barely have time to read? The apps you barely recognize? Figure out first what to declutter.
The second step attempts to reduce the recurrent costs by shopping around and changing service providers. Chances are you haven’t looked at your energy and/or electricity provider bill in detail in years. What prices are the competing firms offering today? Can you reduce your bill by 5 or 10%? What are you waiting for?! Can you tackle as well some of the insurances? You can often find better deals by comparing and switching service providers, saving money each month. These small incremental wins in recurrent expenses–though small in isolation–truly add up quickly, and it is motivating to see your savings rate increase as a result. This is something our household does once a year. Look in detail at your internet provider, phone contract, utilities, insurance, entertainment, etc.. Don’t leave money on the table!
My recommendation is that you play around with this online calculator in parallel, since it will be satisfying to see how fast you can accelerate your path to financial independence after tackling these recurrent expenses. In most cases, it is just a matter of spending 10 minutes and a few clicks on a website… and done–you just locked in €10/€15/€20 monthly savings, permanently. In the worst of cases, it may be a 10-15 minute phone call. Surely though it is worth your time to go through all of these entries if it means cutting your mandatory working career by several years?
After reducing your fixed costs, shift your focus to one-time or non-recurring expenses to boost savings. In the excel sheet, I added a color code to help identify the higher expenses. Here, again, it helps to imagine the impact that not engaging in a certain expense has on your savings rate and financial independence timeline–perhaps next time around you think twice about the pair of shoes you didn’t really need.
Rinse and repeat. For the next month, create a new Excel sheet, copy paste the previous month’s entries, and edit as needed.
Use our three-step decision-making framework to evaluate both your recurring and non-recurring expenses each month, as presented in our previous post:
How much time does it cost? Honor your past.
How much freedom does it cost? Honor your future.
Is it aligned with what I care about? Honor your values.
Please re-label the categories as needed. In my view, the labels and classification you choose (i.e., column F) is not so important. However, the labelling itself may be helpful to help identify some areas (e.g., food) where you may be spending a lot more than you thought.
Track your path to financial independence by filling in the summary tab. We manually took the total income and expenses from the September example and added it to D6 and E6. Combine this information with how much your liquid net worth is growing. After entering your financial independence goal number (C1), you may track your progress towards it each month.
Enjoyed this post? Don’t miss our insights on best budgeting practices for financial independence or on how to invest your hard-won savings.
