In this post, we’ll look at one more financial planning sum that can help you stay “financially fit”.  Grab a pen and paper and get that calculator App on your smart phone running.

Savings Ratio

No prizes for guessing why this calculation could come in handy. The calculation you are about to see shows your level of savings, expressed as a percentage of total income. Worried that you might not be saving enough? Let’s have a quick look:

The calculation: Savings ratio = Savings / Total income x 100

Example: Lindiwe earns R20,000 per month (gross income). She is currently investing R1,000 per month towards a unit trust investment. What % of her income is Lindiwe saving?

R1,000 (monthly unit trust investment) divided by R20,000 (gross income) x 100 = 5%

Lindiwe is contributing 5% of her gross income towards savings.

But there might be a problem with this calculation

Can you spot it?

It’s not so much a problem as it is something to be aware of. The calculation above is working on gross income and we all pay income tax, don’t we?

To get a better idea of your savings, as a proportion of your disposable income, use an after-tax income calculation.

The calculation: Savings ratio = Savings / Net income x 100

If we take the same example above, what % of her net income is Lindiwe saving towards retirement?

R1,000 (monthly unit trust investment) divided by R17,129 (Net income) x 100 = 5,8%

Now for the big question.

What % of your income should you be saving?

The rule of thumb is 20% of your savings (preferably Net income) should be going towards savings. If you aren’t saving at least 20%, you run the risk of not accumulating enough capital to be financially free one day.

There is also the 50/30/20 financial planning concept which suggests that you should be spending:

• 50% of your money on “needs”
• 30% of your money on “wants”
• 20% on savings

‘Needs’ can be described as the essentials that you need to pay for every month, like your bond, car repayments, school fees, groceries etc.

‘Wants’ can be described as the stuff you want…That’s easy enough.

Heading out for a few drinks with your mates is really a “want” even though we might try to justify it as a “need”. Other “wants” might include that new handbag you’ve had your eye on, as well as that island hopping holiday in Croatia next year.

‘Savings’ can be described as any saving or investment, regardless of whether it is a short-term savings plan to cover emergencies or a long-term investment plan for your retirement.

Should we go back to Lindiwe’s example to see if we can apply the 50/30/20 rule to her Net income and personal budget.

What we can see here is the following:

• 61% of Lindiwe’s Net income is going towards paying for her “needs”
• 32% of Lindiwe’s Net income is going towards her “wants”
• 6% of Lindiwe’s Net income is going towards her savings.

It’s obvious that Lindiwe is falling short of the 20% savings mark. She only has two choices:
• Free up money from the “needs” portion of her budget
• Free up money from the “wants” portion of her budget

It’s only when you complete an exercise like this, do you realise how skewed your priorities are. It’s not always that easy to free up money from the “needs” portion of your personal budget, but we can all free up some money from the “wants” section of our budget.

In Lindiwe’s instance, she needs to find R2,000 a month.

Are you on track with your savings? Take the time to do the calculation.

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Until next time,
The Wise About Life team