Personal Finance Dashboard — Part 1 (Theory)

If you have challenging personal financial goals then it’s useful to have a complete and easily understandable way to view your performance. Otherwise it’s like you’re driving a car without dashboard gauges, it can be done but it just makes things more difficult then they have to be. At the very least your financial dashboard should tell you three things:

  1. Your financial risk level
  2. Your savings rate
  3. How financially efficient you are with your ‘assets’ (things of reliably measurable and enduring value).

In addition this dashboard would be complete if we could aggregate you’re entire financial performance down to a single, mother of all, financial performance number. One elegant way of performing this type of analysis is through something that in the business world is referred to as ROE (Return on Equity) analysis.

ROE analysis is a timeless and powerful way to determine how a much “bang” a business generates for each investor “buck” put into it. Your finances are, mathematically, no less amenable to ROE analysis than a business. Therefore the power of ROE analysis can be put to immediate use on your finances.

If you don’t already know about ROE analysis I would suggest you read these articles:

  1. Return on Equity (ROE) and Income Statement Analysis.

  2. The DuPont Model Return on Equity Formula for Beginners.

  3. If you want to do a deeper dive the Wikipedia Article is good.

 

In it’s most distilled form your Personal ROE formula is just:

\text{Personal ROE}=\frac{\text{Savings}}{\text{Net Worth}}

Note: ‘Savings’ refers to yearly savings

However, as you know, the nature and quality of ROE depends on three key levers that produce the final ROE:

\text {ROE} = \text {Equity Multiplier} \times \text{ Asset Efficiency} \times \text {Profit Margin}

I have renamed two of these key levers for Personal ROE as follows:

\text {Personal ROE} = \text {Leverage} \times \text{ Asset Efficiency} \times \text {Savings Rate}

The renaming helps everything make more sense from a personal finance point of view but the concepts are all the same.

Each Personal ROE Lever is a ratio as follows:

Leverage

\text{Leverage}=\frac{\text{Total Assets}}{\text{Net Worth}}

Leverage is a double edged sword because the more leverage you use the more risk you have of becoming insolvent and/or going bankrupt. On the other hand many people have achieved great wealth through the rational and prudent use of leverage. For example successful real estate investors often employ lots of leverage to increase their Personal ROE to a level they would never otherwise be able to achieve without it. The Leverage ratio compares your debts and other liabilities to your assets (things of enduring financial value).

Asset Efficiency

\text{Asset Efficiency}=\frac{\text{Total Revenue}}{\text{Total Assets}}

People don’t often think of using Asset Efficiency to improve their finances, however it’s a powerful lever. This lever has to do with how much money you make relative to your asset footprint. If you’ve got a lot of potential income tied up in unproductive assets this ratio will tell you about that.

Savings Rate

\text{Savings Rate}=\frac{\text{Savings}}{\text{Total Revenue}}}

This is the first thing most people think of when they try to improve their finances. They usually try to spend less money and/or make more money. Spending less money is usually achieved through a budgeting exercise. Making more money is usually achieved by getting a raise, finding a new job or taking on more work.

Putting It All Together

As you can see the product of these three levers is the Personal ROE ratio:

\text {Personal ROE} =\frac{\text{Total Assets}}{\text{Net Worth}} \times \frac{\text{Total Revenue}}{\text{Total Assets}}\times\frac{\text{Savings}}{\text{Total Revenue}}=\frac{\text{Savings}}{\text{Net Worth}}

By isolating each of the three levers of  your personal ROE you can reveal areas of strength and weakness in your finances. You can also better assess how close you are to achieving your financial goals and make more surgical course corrections in your financial life.

I’ll add more levers in a later part of this series (for the real personal finance geeks!) but this simple 3 lever model should suffice for most people.

The Personal Finance Dashboard is underpinned by ROE analysis. ROE analysis is a concept used to analysis businesses for more then a century. We’ve simply re-purposed ROE, a robust and timeless financial model, for personal finance.

In Part 2 we’ll look at an example implementation in Google Sheets. It’s at the implementation stage where we need to make important decisions about how we measure our performance. For example how do you categorize things like school tuition (is it an asset or an expense?). Ultimately you’re implementation is your baby and you make the rules, the main thing is that you need to be consistent with your own rules (don’t fool yourself). In subsequent parts we’ll look at how to expand on the basic implementation for a more sophisticated and personalized dashboard.

Skill Levels

I was researching skill level for another post and although I learned a lot I didn’t find what I was after. To that end I made the following list below to represent different skill levels. I think of skill as something that you can develop through study and action, which differs from talent, traits and aptitude which you either have or don’t have.

Skill Levels

  1. Unawareness:  There are many skills that simply don’t develop at all because people aren’t even aware of them. There is so much going on around us that it’s impossible to even know about it all so we are simply unaware until that first point of contact which is out of our control.
  2. Observation: Once you become aware of a skill you can start studying it in a passive way.  You might read a book on the subject or do some Internet research. Maybe you become aware of a type of music that you really like so you buy some songs and listen to them. Observation involves activities like listening, reading, and watching, it’s a passive activity.
  3. Experimentation: At this level of skill you have dabbled in the field. You’re testing things out and getting better control over your skill. Maybe that music you like involves the violin. So you took some violin lessons which is a form of experimentation that is co-ordinated by a master (the violin teacher).
  4. Mastery: At this level of skill you’ve put in the time to understand how your subject works to the point where you’re in at least the top 5% of people for that skill. You could comfortably teach a motivated student. There are many aspects of the skill that you are able to perform automatically without consciously thinking about it. You understand, and can control for, the few key principles that the skill revolves around.
  5. Creation: At this highest level you are polishing the craft, adding something useful, providing new material for the people in the skill levels below to use. This is the hardest level because you’re doing something that hasn’t been done before, you can’t just look at what has happened before you for answers. You’re ultimately and profoundly responsible for what happens at this level of skill.

Why this personal finance blog is different

I have taken accurate and precise measurements and there is exactly one metric-shit-ton of personal finance content out there in various mediums (blogs, books, videos etc.). Seriously I really can’t add much to what is already out there. However I do think there are some problems that need to be solved:

  1. Overall the quality is extremely variable, meaning some of it is really good and some of it is shit with the rest falling in between.
  2. There’s nothing, that I am aware of, that tries to compile the good stuff, comprehensively, in one place. Most attempts are tainted by the site owners narrow views. For example some people believe that passive investing is the one best way to invest. Other people believe in more active strategies. I personally believe there is no one best way and remain open to new methods.
  3. There are levels of knowledge and skill in personal finance and it’s hard to find the right content for your level.
  4. Too many similar niche blogs. Debt slayers, early retirees, budgeteers, dividend (growth) investing etc. They all offer the same super niche advice, which is fine. However I’d like to show off the philisophical roots of the PF tree and how those roots connect to various idea branches and ultimately manifest into fruit (niche blogs, books etc.).

Goals

My first goal will be to create a freely available compilation of best practices and pre-existing high quality content. This should be structured to solve or avoid the aforementioned problems.

The second main goal will be to fill in gaps and provide integrative insight by contributing my own and possibly others content. I figure the creative part will be fed and improved by the research and compilation effort of the first goal.

My hope is that the first phase of my blog love will be intense and naive enough to put together the initial compilation. After I realize that almost nobody is reading my blog and go through my depressing rejected blog author stage I can focus on maintenance and touching the repository up with new high quality content. After that I’ll probably grow bored with the whole thing and move on to another project but keep up maintenance duties. Maybe this will take 2-3 years.