Many people work in companies and devote 60+ hours / week to those companies. We are often responsible for growing sales and profit, driving volume and coming up with ideas that will meet targets for the year. An important element in every public company is the forecast relative to the target or commitment that management has made to the street. This can have implications on profitability, inventory and total shareholder return which managers take very seriously and implement many processes to ensure their success:
Innovation: Companies will perform consumer research to understand unmet consumer needs, match those opportunities up with the production capabilities to develop an innovation pipeline that can be 3-5 years out. These projects are tested with consumers and shoppers in relative environments so companies can gather information to narrow the error range of the estimated volume associated with the innovation.
Trade investments: Companies will invest significantly to entice retailers to support their products with listings in more stores, feature frequency, display space outside of the shelf, pricing strategies to drive incrementality and shelf space to reduce out of stocks and stimulate triggers to purchase in store. Companies will also determine the specific target of each innovation or product segment and develop shopper marketing plans to drive trial, penetration. All of these investments drive estimated volumes with expected investment payouts that justify the spend; these estimates often roll up and translate to financial guidance that gets to the street. Post game analysis is usually required to understand the impact these investments have had on the business and relative to what was projected all with the hope of optimizing investments.
Marketers do similar planning and analysis using techniques like Market Mix Modeling which is a statistical analysis on sales and marketing data to estimate the impact of various tactics (marketing mix) on sales and then forecast the impact of future sets of tactics.
Before a year even starts, these companies compile a list of “Building blocks” which include last years base volume, planned innovation, trade and marketing investments with the volumes associated. The team then tracks each of those building blocks in a phased approach throughout the year.
This seems like a very rigorous logical and data based approach with elements that could be reapplied to our personal finances to drive a better return. Some steps that could be taken on the personal finance front include:
- Tracking historical Assets and the return they have delivered.
- Tracking the growth trajectory of various asset groups
- Tracking the management of expenses.
- Tracking various financial ratios like savings rate, Monthly investment income / expenses
- Targets for the years net worth broken out by quarter
- Building blocks to help drive the net worth target with regular tracking.
- % of net worth in tax deferred accounts
- % of tax deferred investment room being used.
- Budget required while in the work force vs. in retirement.
- Portfolio mix vs. desired allocation over time.
Tracking our personal finances is just as important as our company business because after all, it is our business!
Retirement needs to be reframed. It is not about your income and how much of it you can replace but rather how much you spend and how much your investments bring in.
Your education, work ethic and passion in your career can help you earn more money but once you get into the work world for a while, your income becomes a bit more stable and starts to plateau. As this happens and your career lengthens, large income bumps become less and less in your control or they could require dramatically more of your time. Your expenses however are controlled by you for every cent you spend.
There is another concept that is very important in building wealth or value. In business a company’s worth is based on its owners equity on the balance sheet. If shares are issued of that company, the share price is the owners equity / number of shares. That value is what shareholders expect to increase and why they invested in the company. My point is that your balance sheet matters not your income statement; if you make $1M and spend $1M you have nothing to add to your net worth or “owners equity” at year end. It is also worth mentioning if you spend more than you make in a year, you will reduce your net worth.
Income statement rich shows up bigger in the world! These people make money and spend it on lavish things: cars, homes, vacations, clothing etc. they appear rich but at the end of the year, they don’t increase their net worth. People focused on expenses and make the same money have lots left over at the end of the year to add to their net worth that they can put to work via investments for them.
4 Step plan to get started:
- In a spreadsheet track your net worth; list your assets down a column, your liabilities, and the difference will be your net worth; record the months across the top and do this each month.
- Track your expenses via an app called “Mint” then at the end of each month, drop that amount into a spreadsheet with months across the top. I also like to reduce this number by work related expenses. Examples could be work clothing, toll roads and gas on the way to work, eating lunch at work vs. at home, dry cleaning, camps for kids during the summer etc.
- In a line below your expenses calculate the cash flow that would be generated by your invested net worth; using the 4% safe withdrawal method this calculation would be =networth*0.04/12 to get a monthly number; you can also include other sources of income like rent from a rental property etc. If you are in a home you want to sell soon, you could include that in your calculations but if you don’t plan on moving and pulling equity out of your home, I would not include it.
- Track your savings rate by taking any investments you made or principal paid on your mortgage and divide it by your after tax income. Your goal will be to increase this rate as much as possible. One analysis showed that if you can have a 50% savings rate, you can retire after 17 years! That would require living off of 50% of your income.
Once you have tracked this over time, and your income line has consistently been above your expenses line with some cushion, you should be able to pull the trigger. This becomes a math exercise where you need 25x your annual expenses to be able to withdraw 4% each year.
To summarize this equation, ((Net worth (Assets-liabilities)) – home equity) * 0.04 / 12 – Monthly expenses. If positive your investments cover your expenses and you don’t need to work anymore. Further posts will focus on how to increase your assets, reduce liabilities and expenses but have fun doing it!