Learn how the same principles that guide the most successful companies in the world can be used to radically improve your personal finances. In Part One, we introduced the personal finance mission statement. Then, Part Two explored how to translate this mission into action. Part Three presents a system designed to measure daily progress and ensure you crush your financial goals.
Where We Are: Charting Progress on the Fortune 500 Framework
Recap
Over the past two posts, we’ve discussed how to implement best-in-class corporate principles into your personal finances.
In Part One, we started with the corporate mission statement. Lofty evergreen ambitions, concisely stated, with a direct call to action. We then translated this into the personal finance mission statement to help frame your individual journey.
Next, Part Two outlined how to convert the ambitious goals presented in the personal finance statement into everyday action. Corporations rely on the employee handbook to accomplish this. In personal finance, the financial handbook serves the same purpose.
Next Up
Now, time to tie it all together. Part Three establishes systems to objectively monitor performance and track the impact of daily actions. Companies establish Key Performance Indicators (KPIs) to review execution at regular intervals. They typically do this more informally on a monthly or quarterly basis, before presenting these findings formally at annual board meetings.
These organizations use KPIs to track performance across various divisions. The measurements provide executives and board members with the information they need to evaluate alignment with strategic goals and the overarching corporate mission. If problems begin to bubble, management can use KPIs to trace issues to their source and correct underperformance before it spirals.
In your personal finances, we’ll call the parallel concept Key Financial Indicators (KFIs). The idea is to track each aspect of your own financial performance, ensuring tight alignment to your personal finance statement. As you inevitably notice yourself drifting, pause. Diagnose the issue using your KFIs, then reset.
Do not aim to obsessively micromanage here with daily updates or minute-by-minute stat chasing. Instead, remember that winning the personal finance game is about patient, measured action. Look at these metrics no more than once per month. I recommend a quick quarterly review and an annual deep-dive at your “board meeting.”
Key Financial Indicators for Your Personal Finances
This section is structured to mirror the ideas presented in Part Two’s recommended financial handbook outline. If you haven’t had a chance yet, circle back and read Part Two to see detailed instructions for how to create your financial handbook. This will ensure that you derive maximum value from the Key Financial Indicators mentioned below.
Without further ado, let’s dive in!
Spending & Saving – Key Financial Indicators
Savings Rate
As mentioned in Part Two, the most pivotal metric to establish here is the savings rate. Recall that the savings rate represents the percentage of your income that you elect to save and invest. To calculate this, simply add the contributions that you make to employee-sponsored retirement plans, IRAs / Roth IRAs, after-tax investments and other savings each month. Then, divide this sum by your monthly gross income.
The retirement plan portion of your monthly savings will be automated through your company’s 401K portal. I also set up automatic transfers from the checking account where my paycheck is deposited into taxable brokerages and alternate savings vehicles. This builds an additional layer of automation into my savings to keep life easy.
Emergency Fund Multiple
Our bulletproof plan for your personal finances recommends building a 3-6 month emergency fund. That is, your fund should be large enough to cover 3-6 months of your living expenses. Keep in mind, you’ll want to double that amount if you’re pursuing our advanced HSA protocol.
The emergency fund multiple is a quarterly metric that gauges fund size relative to recent spending patterns. To calculate it, divide the value of your emergency fund by the total expenses incurred over the prior quarter.
For instance, say that your emergency fund totals $15,000 and your spending from Quarter One (Jan-Mar) sums to $10,000. This scenario yields a 1.5x emergency fund multiple.
The higher this multiple grows over 1.0x, the more conservative your emergency fund amount. If it falls below 1.0x, you might consider allocating additional assets to your emergency fund as it wouldn’t have fully covered your spending over the prior 3-month period.
One final point: the way you store the emergency fund should influence your optimal multiple. If employing a riskier strategy such as holding it in equity funds, target a multiple well above 1.0x to provide more cushion.
Investing – Key Financial Indicators
Rate of Return
The most unsurprising investing KFI is, paradoxically, one you should not track. Assuming you invest primarily in long-term equity ETFs and mutual funds, analyzing rates of return on anything less than a 20-30 year horizon is distracting at best. And detrimental at worst. Shorter term return data will simply tempt you to make changes that will hinder overall performance.
Now, there is an important caveat here. If you invest actively in individual equities, real estate deals, and so on, you must track returns quarterly or annually. Why? These concentrated investments are highly influenced by you. They’re active. It’s imperative that you track your return on these investments since you are exerting incremental effort. If you cannot generate outsize returns compared to passive investments, you should reconsider your strategy and the value of your time.
Blended Expense Ratio
In the case of a portfolio primarily comprised of ETFs and index funds, the most important investing KFI to track is the blended expense ratio. That is, the total amount of expenses that you pay across all funds divided by the total amount of assets you invest in said funds.
Simple enough if you hold one or two funds. But what if you invest across 20 or 30? This calculation becomes burdensome.
Luckily by creating a free account at Personal Capital, you can track this metric seamlessly with their fee analyzer tool. This is one of my favorite features on the entire platform. (Note: Both Cash Snacks and readers will receive a referral reward from Personal Capital if this link is used for sign-up.)
Remember, we can’t guarantee fund performance. We can’t know that strategies that have excelled in the past will continue to outperform. Or vice versa. But we do know that minimizing fees will boost overall returns. Period.
Debt Management – Key Financial Indicators
Debt to Discretionary Income Ratio
This metric demonstrates the relative burden of your debt compared to cashflow. It roughly approximates the length of time it would take you to pay down all debts assuming every discretionary dollar gets dedicated to this goal.
Calculate the ratio by dividing total debt outstanding by annual gross income less unavoidable annual expenses (food, housing, taxes, transportation, utilities, cell phone, medical, etc.).
Lets illustrate this concept with an example:
- Jim holds $80,000 in debt and has $50,000 in discretionary annual income
- $80,000 / $50,000 = 1.6x
This means Jim could theoretically pay off all debt in just over a year and a half (ignoring the impact of compounding interest or mandatory repayment plans). I don’t recommend that Jim actually attempts this! It would likely lead to a period of severe deprivation and social isolation, but it’s a useful benchmark for Jim to track.
Weighted Interest Rate
This indicator acknowledges the fact that not all debt is created equal. While the debt to discretionary income ratio lumped all debt together, the weighted interest rate assesses how “harmful” this debt might be.
Calculate this rate by multiplying the balance of each debt by its interest rate, adding the results together, and finally dividing by total debt outstanding.
For example, Jim’s debt might be comprised of:
- $30,000 balance at 10% interest
- $30,000 balance at 8% interest
- $20,000 at 3% interest
- ($30,000 * 0.10 + $30,000 * 0.08 + $20,000 * 0.03) / $80,000
- = 6,000 / 80,000
- Jim’s Weighted Interest Rate = 0.075 –> 7.5%
- ($30,000 * 0.10 + $30,000 * 0.08 + $20,000 * 0.03) / $80,000
As discussed in Part Two, you may choose to establish an interest rate threshold in the debt management section of your financial handbook. If you implement a threshold, use incremental savings to pay off debt until your weighted interest rate equals your threshold rate. Beyond that point, begin investing in assets while making minimum payments on the debt.
Philanthropy & Legacy – Key Financial Indicators
Finally, the toughest section of the financial handbook to quantify. The impacts of philanthropy and legacy-building activities are often intangible or hard to measure on a single scale.
Consider the contrasting schools of thought on philanthropy. You could aim to maximize the number of total lives impacted by your giving or the magnitude of this impact on a single life.
The water is further clouded by differing views around generational wealth. Some may wish to provide their heirs with as much money as possible while others hope to give it all away. For this reason, we’ll lump philanthropic and legacy-building activities into a single (imperfect) metric.
“Selfless Spending” to Net Worth Ratio
Selfless spending includes all philanthropic or generational wealth-related cash outflows.
The philanthropic component of selfless spending is relatively straightforward. Add any donations or contributions to non-profits, charitable foundations, donor advised funds, etc.
The generational wealth piece is a bit more nuanced. There are countless strategies that can be employed to pass along wealth to heirs in a tax-efficient manner. This includes contributions to 529 college savings plans, tax-free gifts, trust fund contributions, generational businesses and many others.
After tallying your total annual selfless spending, divide this sum by your net worth. The result is your selfless spending to net worth ratio.
Personally, I’d like to grow my ratio each year. Of course, even with a flat ratio, the absolute dollar amount of my selfless spending will rise assuming my net worth grows. But I believe the ability to spend selflessly rises disproportionately quicker than net worth.
For example, an individual donating $1,000 with a $100,000 net worth achieves a 1% ratio. This $1,000 likely stretches that person more than donating $10,000 with a $1,000,000 net worth. The selfless spending to net worth ratios are equivalent, but the noticeable effect of this spending shrinks for the wealthier individual.
Key Takeaways on Fortune 500 Personal Finances (Part 3)
In Part One, we discussed the importance of the corporate mission statement and how to extend this concept into a personal finance statement. This document guides our overarching mission and ideals. It focuses our actions towards a higher purpose.
Then in Part Two, we explained how to translate this purpose into action. At the corporate level, this is accomplished with an employee handbook. At the individual level, we created a financial handbook that ensures daily actions align with our mission.
Finally, here in Part Three, we tied things together, establishing performance metrics that measure the efficacy of these daily actions. Large organizations use KPIs to gauge management performance across divisions and diagnose issues before they have time to compound.
Similarly, your KFIs will allow you to evaluate performance across the major facets of your personal finances, implementing changes when necessary and promoting momentum towards positive outcomes. As one of my mentors always says: “You are what you measure.”