Yes, you read that correctly. And it’s true…within a certain context that is. Context is critical when discussing personal finance. Let me explain.
A savings example
What if I told you John & Jane saved 15% of everything that they earned. Would you be impressed? I would, I think 15% is a fantastic savings rate.
Is it so fantastic, though, when compared with the 50% that Chris and Christine save? Chris & Christine are obviously doing a better job, right?
The fact is, we don’t really know. We don’t have any context. So let me give you some.
John & Jane have 4 kids. Jane stays home, and John makes $60,000 per year. Their 15% savings amounts to about $9,000 (after tax), which means they’re living on about $45,000.
Chris and Christine have no kids and bring in a combined income of $130,000. They save 50% of their gross income, which is about $65,000 per year! That puts their after-tax expenses right around the $45,000 mark as well.
So which is better? The family who lives on $45K and saves 50%? Or the family who lives on $45K and saves 15%?
I can’t say for sure. What does better even mean?
A savings rate alone doesn’t tell us much.
If we know one’s expenses in addition to one’s savings rate, we can at least figure out what the income is mathematically to get a more complete picture.
But then what about geographic location, family size, medical conditions, charitable contributions, standard of living, etc.?
We all know we shouldn’t do it
The bottom line is that although we like to think quoting things in terms of percentages makes things comparable, it doesn’t. There are just too many factors, which precludes perfect comparisons.
Consequently, we ought not compare. We all know this, but since none of us follows this rule of thumb, we settle for imperfect comparisons.
Before you start feeling bad as a result of your friend who boasts a solid 45% savings rate, make sure you know what his or her expenses or income are.
If you know she makes $100K (and assuming she’s telling the whole truth), you can assume that she’s living on about $55K (let’s ignore taxes here). Now if you make $100K as well (and live in the same area, have the same amount of kids, have the same medical issues, same this, same that, etc.), and you’re only saving 10%, well then you should definitely be feeling bad about yourself.
I kid! But you get the point. The fact is that there is rarely an equal comparison.
A real life comparison
When my wife and I were just over a year into our marriage with a little baby on an income of about $47K, I remember a friend telling me that he and his wife were saving over 50% of their income. I thought that was fantastic, but the kicker was that he didn’t see any reason why everyone else couldn’t be doing the same.
As Amanda explained last week, we lived as frugally in every other area of our lives as we did with our “startup” baby expenses. We used our air conditioning sparingly during the Arizona summers. We only had one car. We could not have found a cheaper apartment unless we were willing to live in some very sketchy housing. I thought we were doing amazingly, saving around 30%. “Should I really be able to save 50% too?” I wondered.
This guy and his wife lived in a different state, had a different level of income, and had no kids. The reality was that I had no business feeling bad by comparing my savings rate with that of my friend because there were just too many differences for us be comparable.
Side note: A few years later, he and his wife had twins…and guess what happened to that 50% savings rate? (hint: it fell off a cliff.) Was I happy for him? Yes I was…for the babies of course.
It’s all about your income
When it comes down to it, there is a limit to how much we can skimp on toilet paper and how much Ramen we can eat before becoming nutritionally deficient.
I am all in favor of living frugally, but if we are diverting so much of our energy and creativity toward figuring out how to save on costs, we are missing a huge opportunity.
That opportunity is to grow your income. Your income is generally the biggest driver of your savings.
If John & Jane could double their income and manage to keep their lifestyle under control, they would triple their original savings rate!
The action with the most significant impact on increasing my own income was returning to school for an MBA. Furthering your education is always an idea worth exploring.
If you are looking for other ways to increase your income, think about how to pair up your interests and skills with market needs. Here are a few articles you can check out to get your creativity flowing.
Young Adult Money – 10 ways I’ve made side income
Budgets are sexy – 50 ways to make money
Making Sense of Cents – 10 Ways To Make Money Online From The Comfort of Your Home
- Do not compare…but since we’re human and we know everyone ignores that advice…be willing to put some context around your savings rate when you share it.
- Remember that income is the biggest driver of your savings.
While we are on the topic of comparing, check out my growing collection of budgets from people everywhere. If you have a question on how to generate more income or where you could be cutting costs, submit your budget, and provide some context in the submission form of what type of guidance you are looking for.
Do you find financial comparisons helpful? Where have you been able to make the biggest difference in your savings rate – through limiting spending or increasing income?