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.