What financial measure or metric most influences your behaviours?
Banks would say it is your account balances. They are prominently displayed right there on the home screen when you access internet banking. Which makes sense from the bank’s point of view, they profit from your continued usage of the financial products they sold to you.
Brokers would say it is your current portfolio valuation. It is the first thing you see after logging into their dealing portal or app. A logical choice from the broker’s perspective, their revenue derives from the activity and ongoing holdings in your accounts.
Those metrics favour the interests of the institutions. Which metrics best serve your interests?
William Bengen, the rocket scientist turned financial advisor famed for coining the 4% “safe” withdrawal rate rule of thumb, based his analysis on tax-deferred investment portfolio balances.
Think about that for a second.
Not your bank balance.
Not your net worth.
Not your house.
His research focused on ensuring decumulation phase investors would not outlive their money. He wasn’t interested in fees, taxes, or whether those “safe” withdrawal amounts could support the investor’s cost of living.
Jacob Lund Fisker, another space scientist turned financial imagineer, figured out that the lower your household expenditures, the lower the initial portfolio balance that would be required to sustain your lifestyle costs without exceeding Bengen’s “safe” withdrawal rate.
Which meant Early Retirement Extreme focussed on expenditure. Frugality. Minimalism.
Not your salary.
Not your state pension.
Not your stock picking or lottery number selecting abilities.
His writings covered his journey toward the point where time investment decisions became independent of finance. Early retirement in this context meant retiring from having to earn a salary, as opposed to retiring from all forms of paid work.
Pete Adeney built upon the ideas of Fisker and Bengen. Observing that it wasn’t what you earned that mattered, but what you kept. Saving 10% of your income may see you successfully accumulate within 50 years the required portfolio balance to sustain your lifestyle within Bengen’s “safe” withdrawal rate. The same person saving 70% of their income could potentially get there in less than 10 years.
Where Early Retirement Extreme focussed on expenditure, for Mr Money Moustache the most useful metric was savings rate.
Not pension lifetime allowances or superannuation general balance caps.
Not 10-year CAPE ratios nor 18-year property cycles.
Not the value of a potential future inheritance.
Mr Money Moustache’s approach concentrated on two financial levers, rather than just one. Maximising earnings while minimising expenditure to achieve the desired outcome sooner.
Each of Bengen, Fisker, and Adeney attracted large followings, who eagerly bought into their financial philosophies.
Each used different measures to help them conquer a specific financial hurdle.
It is worth noting that each approach helped its author solve a specific financial problem.
Once achieved, all three authors moved on and lived their lives. Adeney sporadically continues to write about money. Bengen and Fisker stopped altogether, as money no longer influenced their decision-making nor dominated their thinking. They were independent of finance.
At the time of writing, Bengen was happily retired. Seeking certainty and peace of mind in his elder years, he chose not to apply the 4% “safe” withdrawal rule to sustainably fund his own retirement.
After achieving financial independence, Fisker and Adeney have each spent subsequent years working in roles chosen because they wanted to, rather than they had to. Builder. Co-working space operator. Quantitative analyst. Watchmaker.
Balancing work they found meaningful with play. Bikes. Boats. Children. Jump rope. Skates. Swords. Weights.
The financial metrics or measures relevant to their journey toward the milestone of financial independence have likely been replaced by a different set of measures that are more relevant to the next stage of the journey. An evolutionary process of tailoring approach to circumstance.
Now that you’ve had time to think about it, I’ll ask again: what financial measure or metric most influences your behaviours?
A single number that represents what you own less what you owe.
An interesting figure, but what do you do with it?
Chart progress over time. An analysis meaningful only if adjusted for changes in purchasing power.
Brag when it increases. Moan when it falls. Reactions that make sense early in our financial journeys, when the movement is solely determined by our individual actions, saving or spending. Reactions that become irrational once the movement is driven by market movements or rising house prices.
The composition of that net worth figure matters, as not all wealth is of equal value.
Age-restricted pension valuations are a mirage until we reach eligibility age. Tantalising, but untouchable.
Accumulated home equity may be inaccessible should we wish to continue living in that home.
Regulatory risks aside, the state pension has a financial value similar to an annuity. How many of us incorporate that annuity value in our net worth figures?
Future capital gains tax liabilities may be constantly accruing as our portfolio values increase. Yet who amongst us carries a provision for taxes that may one day be owed in their net worth figure? That’s fine for those who never intend to sell, but problematic for those planning to finance their lifestyle by decumulation.
Cash flow is another interesting metric. Income less expenditure equals saving.
This measure has a more immediate impact on our financial well-being. We may be a millionaire on paper, but may not feel like one if we struggle to pay for groceries or heating. Asset rich, but cash poor is an uncomfortable position to find ourselves in.
When correctly calculated, net worth measures how rich we are. Cash flow measures how rich we feel.
It is those feelings that are our lived experiences. Influencing behaviours. Controlling decision-making.
Breaking down the constituent elements of that cash flow metric can tell a fascinating story.
Income earned from selling time, versus passive or unearned income that investments generate. Financial independence is attained once that passive category covers lifestyle costs.
But wait! Passive income usually only covers dividends, interest, rent, and royalties. What about the sale of investments, as called for by the 4% “safe” withdrawal rule of thumb?
Sale proceeds represent a cash inflow. After accounting for fees, the remainder is income, upon which taxes may be owed.
How about a metric of total returns?
If those savings over and above what is required to meet our immediate needs are invested, then we should monitor and compare their performance against various benchmarks or other asset classes to ensure we are not doing it wrong.
Some investments generously make distributions in the form of dividends or rental income.
Others choose to retain and reinvest profits. In many jurisdictions, government policy currently taxes capital gains more favourably than other forms of investment income. Influencing behaviours.
Therefore, to be valid, any evaluation of investment returns should include both capital growth plus any distributions received. In other words, total returns.
If we are contributing additional capital to our investments, such as regular employer matched pension contributions, then it can be easy to deceive ourselves that our performance is better than it really is. Additional capital contributions potentially offset or disguise falls in investment value.
To account for this, any comparison needs to be done on a unitised basis. This ensures it is actual investment performance that is monitored, rather than the value of our current position.
Unitised total returns allows investments held in cash or premium bonds to be compared to those in antique cars, art, cryptocurrencies, direct business ownership, horses, options, property, shares, trading cards, or wine.
Perhaps some form of coverage ratio is more your thing? What multiple of your annual household expenditure does your net worth represent?
Depending on the result, such a measure provides motivation or comfort about the state of the observer’s financial position. Perhaps allowing them to loosen the purse strings or telling them to tighten their belt.
What about a time utilisation metric? The number of working days/weeks/months per year that your current portfolio balance is capable of sustainably providing funding for, buying back control of your time.
This allows the observer to either work less for the same money, or switch to a potentially more enjoyable yet lesser remunerated vocation. Increasing the marginal happy factor of each hour invested in work. Over the long term, that has a powerful compounding effect indeed!
Which financial metric makes the biggest difference to your own behaviours?
The wisdom of children
I was talking to one of my elder son’s friends earlier this week. A kid blessed with a big brain, cursed with an even bigger mouth, and enduring a tough home life. Constantly drawing fire from his teachers for showing them up. Achieving high grades while coasting his way through high school, the kid could be virtually anything he wanted to be in life.
I asked him what professions he was thinking about joining after university?
He wanted to be a nuclear engineer, or failing that a computer “engineer”. Not because he had any particular interests or talents in either field, but rather because they ranked amongst the top remunerated professions.
Why was the remuneration a material factor, I asked? His response simultaneously impressed and dismayed me.
So that he could save up enough to retire by the time he was 40. Then his life could start. Free from the financial pressures and influences that drove his parents’ behaviours, destroyed their marriage, and dominated their decision-making.
Many FIRE-seekers desperately wish to escape from the daily grind of commuting, competing for a “hot” desk, forced socialisation with acceptably incompetent colleagues they don’t care for, and humouring a pointy-headed boss. Running away from a life they had found wanting. Placing all their faith in the idea that financial independence will cure all that ails them.
It won’t, but some things we need to learn by doing.
This kid had given up on the possibility of an enjoyable or rewarding career before he had even started.
His instincts weren’t wrong exactly, but they were certainly disheartening. It is true that many jobs, and more than a few careers, are unfulfilling. Many grown-ups might go as far as attesting that becoming an adult is a trap. But I felt saddened that he and his classmates (including my son) had already seen through the game at such a young age.
I asked him with such a plan, how he saw the money side of his life playing out?
He envisaged landing a high-paying job in a high-paying city. Working hard to advance, while he was still unencumbered by dependents and competing priorities. Changing jobs often, to climb the career ladder and boost his earning power.
Living modestly throughout, because he wouldn’t have much time to enjoy life outside of work. Consequently, there was little point in accumulating trinkets and trophies.
Saving and investing the difference to build up the nest egg required to finance the next phase of life.
At the age of 40, or whenever he felt like he had a large enough financial cushion beneath him, he would quit. Climb off the career ladder. Move somewhere desirable to live, that was also cheaper than the city. The beach, countryside, or mountains.
At that point, he would buy a home.
Maybe couple off and start a family, now that he could afford to pay attention to them.
Start doing a job he felt was rewarding. Contributing to society or pursuing an interest. Teaching or academia appealed to him. So too did becoming a paramedic.
His model for paying for this life plan was simple.
The first phase was financed entirely via salary.
For the second phase, it was accessible investment income that needed to do the heavy lifting. Aside from a mortgage deposit, his ongoing housing costs could be kept to a minimum via an interest-only mortgage in a low cost of living locale.
His third phase, would be funded via pensions once he was old enough to receive them.
Initially, the workplace pension he would have contributed to during phase 1, which would hopefully have compounded to a nice big figure over the 30-40 years his contributions would have been invested by then. An initial tax-free lump sum withdrawal would pay off the mortgage.
Subsequently, his private pension income would be supplemented by the state age pension.
It was a simple financial plan. From the mind of an academically gifted 15-year-old with more experience of “life happens” events than any kid his age should have endured. He’d given the big picture plenty of thought, but the finer details needed some work.
As a thank you for sharing his thoughts, I helped him open a Junior ISA account, so that his hard-earned savings would start compounding in a tax-efficient manner. In 25 years’ time, that should make a big difference to his chances of success.
After the boys headed off to the movies, I thought about what financial metrics he would need?
His plan focused on cash flow, but would require different measures as his journey progressed.
The marketable value of his time, savings rate, and net worth to begin with.
Total returns and “safe” withdrawal rates to follow, to ensure his money worked hard and he didn’t outlive it.
Before concluding with simple cash flows.
An evolution in metrics that could apply to many of our journeys, as we advance along the financial maturity curve.
Ask the audience time: what financial measure or metric most influences your behaviours?
- Adeney, P. (2012), ‘The Shockingly Simple Math Behind Early Retirement‘, Mr Money Moustache
- Bengen, W.P. (1994), ‘Determining Withdrawal Rates Using Historical Data‘, Journal of Financial Planning, October 1994
- Fisker, J.L. (2019), ‘Early Retirement Extreme: The ten-year update‘, GetRichSlowly
- Networthify (2022), ‘When can I retire?‘
- Templin, N. (2021), ‘The Originator of “the 4% Rule” Thinks It’s Off the Mark. He Says It Now Could Be Up to 4.5%.‘, Barrons