Monitor Your Finances

MathContributed by John E. Rice, CFA®, CFP™ Everyone wants to monitor their finances. Here is a systematic way to evaluate how well you are doing financially. Each year there are two numbers you should look at to assess how well you are doing. One you have more control of than the other.

The one you retain some control of is to evaluate how much you saved or spent. The one you have less control over is to evaluate how your net worth changed by ups and downs in asset prices and your overall contributions or withdrawals. There are variations of these and additional considerations but if you can start by monitoring and assessing these two metrics you have a great start on monitoring your finances.

There are important distinctions between the two measures besides how much you can actually control these numbers. The first measure, overall spending/savings, attempts to measure how well your contributions and withdrawals stack up against either your annual income or your overall net worth. (more on that later). The second measure, rate of change of your net worth, helps you to keep track of your overall progress towards your long-term goals.

In order to measure both of these factors you need to develop a personal balance sheet at the beginning and end of each year. If you are a client of KeatsConnelly we can help with this

Metric One – How much did I spend or save?

Your assets that have contributions or distributions generally fall into three categories – bank accounts, investment accounts, and real estate. Some of  you that read this will also have business interests where you contributed or withdrew capital, and these represent a fourth category that should be added.

You can easily figure out the net change in your savings account. The difference between begin and end values, minus the interest earned, is the amount you spent or saved in bank accounts.

You can do the same for investment accounts. KeatsConnelly provides reports that show net inflows/outflows from accounts. So you can easily monitor how much was spent or saved in your investment accounts.

If you own a home and pay a mortgage a small portion of your mortgage goes to pay off principal, and this should be considered savings for purposes of measuring how much you spent or saved during the year. Other costs like taxes, insurance, and maintenance, should not be included.

If you have business interests that provided or required cash flows in the year you can net out your contributions/withdrawals in order to determine your net change here.

Add up all these numbers and check it against your income at beginning of the year to determine what percent you spent or saved. If you are in savings mode and still building your nest egg for your retirement, a good reference goal to reach for is to save 20% or more of your annual income.

If you are already retired then you should be monitoring how fast your assets flow out relative to your beginning portfolio value. A good measure here is that your annual outflows should be no more than 4% of your net portfolio. Note that you may be able comfortably spend much more than 4% if you are planning to sell a house and downsize or anticipate some other large cash inflows in the future.

To sum this up, the measures in savings mode are to measure your annual savings against your income. In retirement mode you should measure your spending against your beginning portfolio value.

The second factor to monitor is how much your net worth increased or decreased during the year. Note that this is related but distinct from your savings/spending. You don’t have much control over asset price fluctuations but you should still measure the net increase/decrease in your net worth each year and monitor your progress.

At the beginning of each year create a balance sheet of your net worth. Measure how much it went up or down. Compare how much you spent or saved against the change in value. Then you know how much of your net worth change was attributable to asset price changes. Use this information to help inform how you allocate capital in the future.

Developing a process to monitor your finances in a systematic way each year will help you stay informed about your finances. Otherwise you are just shooting in the dark. We can help with your monitoring and forecasting these factors. Contact your KeatsConnelly financial professional for further discussions.


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