First off lets define the word “emergency” and the word “fund” using a simple google search.
Emergency: “a serious, unexpected, and often dangerous situation requiring immediate action.”
Fund: “a sum of money saved or made available for a particular purpose.”
So an emergency fund is money saved (or made available) for something serious, unexpected (maybe dangerous) and which will be needed immediately. Therefore I see an “emergency fund” as hard cash, in the locally used currency, that one can easily get their hands on.
This fund could be very useful in a situation where the banks, and debit/credit card networks aren’t available. Personally I would only keep like 2 weeks worth of expenses in hard cash at most. It’s at risk of being stolen and I don’t see a realistic scenario where I’d need more cash than that. I’m not aware of any recent developed world disasters where banks, debit and credit networks weren’t available within 2 weeks of the incident. Moreover if the banks and credit card networks are down then you may have a hard time finding places to spend the money anyways. Better to have a plan for food, water and shelter for 2 weeks than a small cash hoard that won’t spend.
You should be budgeting for infrequent expected serious cash needs outside of the emergency fund. These things include:
- Home maintenance
- Car maintenance
- Health care
- Care and support of family
These types of expenses inevitably occur but one cannot know exactly when. I find many people simply ignore these expenses which is very bad. A better approach is to make a rough estimate (12-18 months of expenses etc.) and throw some money into a general fund that will hopefully cover them, this is what most people consider an “emergency fund “. What they are really doing is creating a poorly conceived general fund. I think the best approach is to budget out these expenses then deal with them as follows:
- Use insurance where it makes sense, but be wary of whole life and specialized insurance products that are often very expensive for what they cover.
- If you don’t have the liquidity (cash or assets easily converted to cash) available to cover these large cash outlays then you should consider setting up the cheapest line of credit you can in advance (assuming you don’t already have one). Banks like to give the lowest interest rates to those who don’t actually need the loan. You’d hate to be out of a job and trying to get a loan to fix your house foundation, the bank may charge you more interest or reject you. Note: If you’re the type of person who can’t help yourself and would use the LOC for other purposes then you aren’t my audience. I write for those with above average financial acumen, not interested in the other end of the spectrum.
- Start putting money into separately tracked funds to cover these expenses if necessary. when you need the money you can raid the other funds if necessary. Whether you carve off a piece of your portfolio or put the money into a specific purpose account is up to you. These are expenses that shouldn’t be counted as part of your retirement savings.
Ultimately when the SHTF you should have your emergency fund (for real emergencies!), various general expense funds (expected serious infrequent expenses), an LOC and a liquid portfolio as tools to help you manage.
When I was in business school the professors there believed in making the majority of my assignments team based in order to better simulate real life. I would get frustrated at having to carry a disproportionate part of the workload due to the inevitable group dynamics where one or two group members generate most of the grade. At first I almost always thought that members with lower contribution levels were just loafing, letting me or a small component of us do all of the work. I told one of my mentors, a successful business owner twice my age, the situation and he told me “You can’t turn shit into champagne”. What he meant was that some people are inherently so incompetent, simple or bad that nothing you do will be able to help them. The correct behaviour in these cases is to learn to identify this type of situation and set up support structures for the weak people so they can achieve some success or if necessary avoid these people entirely. He was totally right and I had a much easier time from then on because I was much less frustrated with the situation knowing that the “shit” was out of my control. You might think I’m being arrogant by implying that I was “champagne”. I should note that I graduated on the deans and presidents lists and was on a partial scholarship. At the same time I started a business (which was unsuccessful) and had a part time job to pay the rent and put food on the table. I still found time to socialize, have a girlfriend, read, goof off and generally have a good time.
Life has definitely allocated me my fair share of “shit”. For example when it comes to maintaining proper diet I am almost entirely incompetent. People, usually skinny people, often tell me things like “Don’t eat carbs!” or “just eat smaller servings and walk more”. I understand this intellectually, it’s easy to understand, but it’s not really helpful in the heat of the moment. I still haven’t found a way to control my eating but I keep on trying different things in the hope that I’ll find something that works for me. However if I was suddenly thrust into a massive physical team effort like competitive sports or the military I’d probably end up getting benched or thrown out.
Up until recently I thought that I was going to be able to help people who are inherently bad with money. I was idealistic in thinking maybe these folks just haven’t heard about how learning to be happy with less so you can get your freedom is the ultimate goal.
I am constantly running into the people who simply won’t follow any reasonable financial advice. They don’t save their money. They have little curiosity about investing and don’t really care about the glories of FIRE. Around 95-99% of all people are probably like this. They can’t delay financial gratification very well, they often spend their entire paycheque and then go ahead and borrow money so they can spend future paycheques too. They probably only think FIRE is a great idea when they’re 50 years old and their employer let’s them go and they can’t find comparable work because nobody wants to hire someone that old who might retire in 5-10 years and could have trouble adapting.
I am interested in the group who would listen to my advice. The interesting thing about that group is that they probably already know and practice a lot of what I would recommend. A lot of them are better at it then me, maybe most of them. We’re all personal finance champagne, some of us are just better champagne. The quality differences amongst champagnes are obviously much narrower then the difference between the worst champagne and the best shit (not that I am a shit connoisseur).
So don’t short change yourself, if you’re reading this blog you’re likely personal finance champagne (or at least sparkling wine), work on becoming Dom Pérignon! Also stop worrying so much about the shit, there’s not a lot you can do to get people with shit behaviour to your level. You can try to support these people in a way that works for them or you can just avoid their shit behaviour altogether.
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 than they have to be. At the very least your financial dashboard should tell you three things:
- Your financial risk level
- Your savings rate
- Asset Efficiency (explained later)
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 much “bang” a business generates for each investor “buck” invested. 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:
- 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:
Note: ‘Savings’ refers to yearly savings
The nature and quality of your ROE depend on three key levers:
I have renamed two of these key levers for Personal ROE as follows:
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 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).
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.
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:
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 widely employed idea that has been used to analysis businesses of all sorts 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.
The scammers among us
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.
- 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.
- 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.
- 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).
- 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.
- 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.
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:
- 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.
- 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.
- There are levels of knowledge and skill in personal finance and it’s hard to find the right content for your level.
- 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.).
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.