There are a lot of different opinions about saving and investing rates, for example whether we should aim for a particular absolute amount or a percentage, whether we should calculate this as a percentage of our gross income or net income, and even whether we should treat investing the same as saving. How do we know how much to save or invest?

As I’ve mentioned before, it’s not wise to make financial decisions to keep up with what most other people are doing. Not least because many people are not financially literate or they lack experience or discipline, but mostly because your financial goals are personal so your financial actions should also be personal.

Saving or investing?

Firstly, on the difference between saving and investing. These are not the same thing. Your savings rate, even though it’s a phrase used synonymously with investing rate, is the lower priority. I’m defining saving as keeping money in bank savings accounts or other relatively low-interest accounts, where there is little to no risk of losing this money. Investing comes with inherent risk (and therefore potential for higher returns).

You should aim to invest as much as you can in preference to simply saving, since this is where the vast majority of the returns will come from. Capital growth and reinvested dividends mean the compounding effect is much greater than with saving. So when I say savings rate we should really be talking about investing rate, and if your money is just sitting in a low interest bank account then it doesn’t count as part of the investing rate.

How much should I be investing?

There’s a lot of advice suggesting an investing rate between 20 and 25% of gross income is ideal, but many articles say 10-15% is also reasonable. It’s probably best to invest as much as you can, whilst maintaining a comfortable standard of living, and enjoying your income.

If you’re paying back loans each month this should usually take precedence over the investing especially if it’s high interest debt. Then once this is under control you can filter more into investments.

There’s no particular need to complicate things by doing too many calculations. If you’re like me any enjoy tracking this stuff in detail then fine, but it’s also OK to simply pick a number that you’ll be able to invest regularly (e.g. £250 into a stocks and shares ISA each month), set it up and forget about it, and that will do most of the work for you. You can adjust this number upwards if you get a feeling that you can afford to after a few months.

Net or gross income?

The point about using gross income in the calculation is important. This may seem a challenge because gross income is obviously a higher number and net income is what we’re most used to seeing in our bank accounts after getting paid and paying our bills.

However, saving a percentage of net income is not too relevant, since the goal of all this investing is to have enough to eventually replace the gross income from our salary with another source of income. We’ll still likely get taxed on this income too so it makes sense to target a percentage of gross values.

Keeping everything gross tends to make comparisons easier, and it’s harder to cheat or mistake your savings rate for being higher than it really is if you are using net numbers. You can also include your workplace pension contributions in the calculation as these are taken out of gross salary.

How to calculate your saving and investment rates

You need two numbers. The denominator is the total gross income. Take everything you’ve earned before tax is deducted (across all sources of income, not just salary). If you track your finances using specialist software then this is simply a case of summing the gross income, assuming you recorded it gross. If you record it net then there’s a bit more work to do. Look on your payslips or invoices or whatever records your income before tax.

The second number, the numerator, is the amount of money you have left over after taking care of all expenses. Divide this by the gross income and you have your savings rate.

You can further differentiate this by keeping track of specifically the amounts that go into investments rather than just everything left over after expenses. This would then give you your investing rate.

Using your investing rate

The important point once you’ve got your investing rate is not to worry too much about it. If you’ve never calculated it before then the gathering of the information is the main goal of the exercise. Knowledge is power and allows you to see where you stand against your goals and take action to improve things if necessary.

It’s a good idea to track the investment rate over time to see how you are doing. If you have a change in income (whether higher or lower) then it’s useful to see if you can maintain the same or similar investing rate.

If you find that the investment rate is too high, you might be in miser territory and want to consider implementing a fun budget to enjoy your income in the moment a bit more, with less focus on the future investment amount.

See my previous post on being a financial miser to see the negative effects of saving too much. The effects of saving too little are much more evident. Building wealth is so much more achievable if making contributions is easy, regular and consistent. Set something up, literally anything even if it feels an inadequate amount at the time, and forget about it for a while. Let time do the work.

If you’re below the target investing rate or feel you’re not saving enough the important thing is to invest what you can. Remarkable wealth can be built from small but regular and consistent investments into low-cost index-tracking funds. Make a start with this even if you can’t invest the amount that would be ideal.

Summary

The focus should be on investing, not saving.

Calculate how much of your gross income you are investing each month, compare this against your target (perhaps between 10-25% depending on personal goals) and make adjustments to your investment contributions as needed to get you closer to this percentage.

Continue to track your investment rate each time you update your other financial metrics (monthly, quarterly etc) and make adjustments.

Don’t worry too much about how much to invest, something is better than nothing. Just make it easy to invest regularly and consistently.

Let me know in the comments what your approach is; do you distinguish between saving and investing rates? Thanks for reading.