What Are Savings? How to Calculate Your Savings Rate

What Are Savings?

Savings refers to the money that a person has left over after they subtract out their consumer spending from their disposable income over a given time period. Savings, therefore, represents a net surplus of funds for an individual or household after all expenses and obligations have been paid.

Savings are kept in the form of cash or cash equivalents (e.g., as bank deposits), which are exposed to no risk of loss but also come with correspondingly minimal returns. Savings can be grown through investing, which requires, however, that the money be put at risk.

Understanding Savings

Savings comprise the amount of money left over after spending. People may save for various life goals or aspirations such as retirement, a child's college education, the down payment for a home, a car or vacation, or another future event.

Savings may commonly be earmarked for emergencies. For example, Sasha’s monthly paycheck is $5,000. Expenses include a $1,300 rent payment, a $450 car payment, a $500 student loan payment, a $300 credit card payment, $250 for groceries, $75 for utilities, $75 for cellphone service, and $100 for gas. Since Sasha's monthly income is $5,000 and monthly expenses are $3,050, there is $1,950 leftover as savings. If Sasha maintains this excess as savings and later faces an emergency, he will have some money to live on while resolving the issue.

If someone is unable to put away money as savings, they may be said to be living paycheck to paycheck. If that person experiences an emergency, there is often not enough money saved up to live on and they may risk falling into debt or bankruptcy.

Types of Savings Accounts

There are different types of savings accounts offered by banks that come with different features or limitations. Note that all bank savings vehicles come with Federal Deposit Insurance Corporation (FDIC) insurance of up to $250,000 per depositor per institution.

Savings Accounts

A savings account pays interest on cash not needed for daily expenses but available for an emergency. Deposits and withdrawals are made online, by phone, mail, or at a physical bank branch or ATM. Interest rates on savings accounts tend to be low but are often higher than on checking accounts. The best savings accounts can usually be found online because they'll pay a higher interest rate. Online-only accounts may be examples of high-yield savings accounts, which can offer interest on deposits that is as much as 10 to 15 times higher than the national average.

Checking Accounts

A checking account offers the ability to write checks or use debit cards that draw from your account. A checking account pays lower interest rates than other bank accounts, and many of them credit no interest at all to checking customers. In return, however, account holders get highly liquid and accessible funds, often with low or no monthly fees.

Money Market Accounts

A money market account (MMA) is an interest-bearing account at a bank or credit union (not to be confused with a money market fund). MMAs often pay a higher interest rate than regular passbook savings accounts and also include check writing and debit card privileges. These also can come with restrictions that make them less flexible than a regular checking account.

Certificates of Deposit (CDs)

A certificate of deposit (CD) limits access to cash for a certain period in exchange for a higher interest rate. Deposit terms range from three months to five years; the longer the term, the higher the interest rate. CDs have early withdrawal penalties that can erase interest earned, so it is best to keep the money in the CD for the entire term. Shopping around for the best CD rate is critical if you want to maximize your investment.

How to Calculate Your Savings Rate

Your savings rate is the percentage of disposable personal income that you keep rather than spend on consumption or obligations.

Say that your net income is $25,000 a year after taxes (i.e., your disposable income) and over the course of the year you also spend $24,000 in consumption, bills, and other expenditures. Your total savings are $1,000. Dividing savings by disposable income yields a savings rate of 4% = ($1,000 / $25,000 x 100).

Savings vs. Investing

People sometimes use the words savings and investing interchangeable—for instance, saving for retirement in a 401(k) plan—but this usage is technically incorrect. Retirement "saving" is more accurately investing, since money put away in these accounts is used to purchase securities, such as stocks, bonds, and mutual funds. When money is invested, it is at risk of loss—but that risk is offset by positive expected returns over time. Savings, in contrast, are by definition "safe" from any potential loss.

Additionally, savings are highly liquid and available for immediate use (e.g., using a debit card to make a purchase). Investments, on the other hand, must first be sold into usable cash. This can take some time and you may incur transaction costs. Investments, by definition, entail some sort of longer-term time horizon to allow the money to grow and appreciate.

The Bottom Line

Savings is the money left over from your disposable income after all of your living and other expenses have been subtracted out. Usually you calculate it for a specified time period, such as a month or a year. Often people set aside savings for certain goals, which may include buying a home, paying for a child's college education, or growing a retirement nest egg. You have options regarding the type of account where you put your savings, such as a savings account, a CD, or a money market account, which are all low-risk vehicles.

In order to make your money grow faster, you may need to take your savings and invest them in securities, such as stocks, bonds, or mutual funds. It's important to have savings, both for times of emergency, such as a job loss, and to ensure a comfortable retirement.