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adverb: to competently express interest, surprise, disbelief, or contempt

The lies we tell

“The fastest vehicle in the world is a rental car with no insurance excess.”

This line from an old Top Gear rerun brought a wry smile to my face. My kids were avidly watching the three hosts racing the length of what may have been New Zealand, pitting a crappy budget rental car against a racing yacht piloted by a very young looking Ben Ainslie.

While not strictly true, the sentiment struck a chord with me. There is a liberating freedom associated with enjoying the usage of something, while avoiding the accountability of ownership.

Rental cars that magically transform into racing cars, rally cars, or off-roading machines in a manner for which they were never designed.

Hotel guests who happily trampoline like young children on the beds, and enjoy a hot shower with a duration measured in hours (without sparing a thought for the resulting utility bill).

Tenants who observe, then choose to ignore, maintenance issues. They don’t want the hassle. The clean-up. The wait for tradesmen who never turn up.

The lies we tell

Recently a reader commented that:

People lie. Numbers don’t

Initially I chuckled at the apparent naïvety of the statement.

My personal experiences as an accountant and working at an investment bank had confirmed many times over the quote:

more fiction is written in Excel than Word and Powerpoint combined!

Then I thought about it some more.

  • Choosing what to measure is a choice made by people.
  • Selecting the method of measurement is a decision.
  • Determining how those figures will be analysed is a judgement.
  • The interpretation of the numbers involves perspective.
  • Making a decision based on that interpretation is an act.

All these activities are performed by a fallible person; subject to the same lapses in judgement, gaps in knowledge, biases and wishful thinking that we all suffer from to varying degrees.

The numbers themselves just are. Objects, like rocks. It is the perspective of the beholder that decides one rock is a worthless piece of shale, while another is a priceless diamond.

Therefore upon reflection, I must humbly apologise to that reader for doubting them, and applaud the wisdom of their perspective.

A person’s propensity to delude themselves is boundless indeed!

Year end rituals

With the holiday season approaching, it is a common practice to benchmark your financial performance over the calendar year.

This time of year presents an opportunity to pause, reflect, evaluate, and… shirk accountability!

Some people will perform a victory dance in celebration of their numbers improving, proclaiming their financial genius, while channelling their inner politician by claiming full credit for the outcome.

Never mind about externalities such as Brexit pounding the Pound, creating a very flattering view of how performant a (wisely) internationally diversified portfolio may actually have been.   

Others will throw a tantrum at their numbers declining. All too often this is followed by seeking to shift blame:

  • The Fed upset the market gods.
  • Trump’s tariffs, trade wars, and conspiracy theories.
  • Brexit uncertainty, the UK government’s unprecedented levels of acceptable incompetence.
  • Raising the migration drawbridge scaring away all the foreign buyers, who have kept the London property market propped up for the last several years.

The problem with blame shifting is that the individual passes up the opportunity to learn from the experience and avoid repeating the same mistakes.

So this year why not try a different approach?

Instead of trying to force your numbers into a narrative you want to believe (the “People lie” part), why not genuinely try to hear the story your numbers have to tell (the “Numbers don’t” part)?

Net worth

Net worth can be defined as what you own less what you owe.

The goal of this metric is to quantify exactly how much you are worth. Sounds simple, right?

Consider some of the following key questions.

Illiquid assets

What valuations do you apply to those assets where there isn’t a clear current market price?

Do you use an estimate? Your own, or one produced by a third party such as a real estate portal or used car price guide?

Do you select comparable recent sales prices? If so, how timely are those figures?

Is the valuation you use for your net worth calculation the same as you use for the purposes of insurance coverage? If not, then why not… they can’t both be right?

Home equity

Do you include accumulated equity in your home?

You could sell your home, so it is definitely an asset, even if it isn’t much of an investment.

You could extract equity by refinancing.

You could take advantage of geographic arbitrage and move somewhere cheaper.

Goods and chattels

How about rapidly depreciation assets, such as your vehicles and home furnishings?

Your insurance policy may offer a “new for old” replacement facility. However that doesn’t mean your goods are still worth what you paid for them.

For larger items there is probably a secondary market price those items would fetch, in all likelihood this will be much lower than you imagine it to be!

When viewed from this disposal value perspective, the vast majority of your stuff is actually worthless… possible less than worthless, in that you may actually have to pay for someone to take them away.

Disposal costs

Do the balances you are carrying factoring in the fees, taxes and charges you would incur upon disposal your assets?

On paper an investment property or shareholding may be sitting on lovely capital gain.

Realising that gain may incur brokerage, conveyancing, or financial settlement charges.

The tax man may also syphon off a material portion of the sales proceeds in capital gains taxes.

Ignoring these costs won’t make them go away, but may provide an inflated view of what you are actually worth.

Business ownership

Does your calculation include the value of your business interests? If so how realistic are those figures?

A business may carry intangible assets such as goodwill on its balance sheet. Examples include the value of its prominent brand, reputation, and impressive list of established customers.

Were that business to be liquidated, those intangible assets would likely prove difficult to turn into cash, a similar story to your household possessions discussed above.

Provisions for future events

Does your net worth account for incurred or foreseeable changes?

You may have incurred, but not yet paid, a significant tax bill. From an accounting perspective this would be classified as a liability.

You may have been awarded, but not yet received, a major performance bonus or sales commission. Accountants would recognise this as an asset.

Meaningful comparison

As you can see there is a great deal of judgement and subjectivity underlying a simple net worth calculation. What works for you is likely to differ for the next person. Without first reconciling the methods use, any form of comparison between your net worth and somebody else’s is meaningless.

We all have a tendency to optimistically value our assets, ignore disposal costs, and inflate our realistic net worths.

This is human nature. It is also an example of people lying to themselves.

However fanciful or accurate your net worth number may be, it serves as a milestone along your financial journey.

A common evaluation involves comparing your current year-end net worth to the previous year. Did you win or lose?

Let’s pause for a moment and consider what is actually occurring.

  1. You are observing account balances and investment prices on an arbitrary date.
  2. You are comparing those figures against balances and prices on another arbitrary date.
  3. Those arbitrary dates are separated by an arbitrary interval, in this case a calendar year.

Providing the rules and definitions applied are consistent there is value in this comparison ritual, as it allows you to evaluate in aggregate how you have performed compared to the previous year.

Analysing net worth

However the real value is digging into that net worth number to analyse and understand what is actually going on.

Consider the following questions:

  • What is the breakdown in contribution to your net worth between investing wisely and excess cash flow? A rising market can mask a multitude of ills.
  • How have the proportions of what you own and what you owe changed? Are you more or less leveraged than last year?
  • Evaluate your asset allocations. Are they materially different to last year? Are they aligned to your target allocations?
  • Determine how much of your net worth is accessible today? Locked away until stock options vest, or your fixed term private equity investment expires? Age restricted due to pension rules?

You may realise that you are asset rich, yet cash poor. All your wealth may be tied up in your home or a pension you can’t touch for another 30 years.

You may learn that between your personal investments and your pension, your exposure to your home market and currency is much higher than you appreciated.

Thinking about how the tax man will pick your pocket when you sell an asset may let some of the air out of your tyres, providing a more realistic perspective on how of your net worth is actually yours!

Savings rate

A savings rate can be defined as the proportion of what you earned that you actually kept.

The goal of this metric is to monitor the difference between your cash inflows and outflows.

Consider the following questions.

Tax status

Do you base your savings rate on gross or net income?

Tax is an expense, just like utility bills or groceries. After housing, taxes are the second highest expense category for many people interested in Personal Finance.

It can be managed, minimised, or avoided altogether… with sufficient planning, risk tolerance and financial acrobatics.

Imaginary income

Do you include employer pension matches and tax relief in your earnings?

The perennial favourite refrain of financial planners, that pension contributions result in “free money” via the government offering tax relief on pension contributions.

This sounds like a foolproof offer at first glance, but for someone contemplating early retirement it comes at the cost of having those funds locked away until pension eligibility age is reached.

That doesn’t make it a bad option, but also means it won’t automatically be the right choice for everyone.

Income sources

Will you include income from all sources (e.g. wages, dividends, gambling, interest, rent, royalties)?

Many people generate income outside of their day jobs. That income may flow into their bank account, or may be channelled elsewhere such as being automatically reinvested via accumulation funds.

The income is real regardless.

If you include that income, for consistency you should also include your investment expenses.

Often times there will be significant costs associated with generating that income, such as financing costs or property management charges.

Investment expenses can form a material portion of a person’s outgoings. There isn’t much point pinching pennies buying groceries that are past their used-by dates if your stockbroker is fleecing you in platform fees!

Invisible expenses

How about expenses that get deducted for you?

Your employer probably deducts tax and employee national insurance contributions from your pay, before you receive it. These are still expenses. The money was yours, now it is not.

Overseas investments may have withholding taxes deducted from dividends they pay you. This money was yours, now it is not.

Most investment fund operators levy management fees on unit holders, the price they charge for administering the fund. These costs come out of the capital you have invested and/or the income those investments generate. Either way, this was your money, and now it is theirs.

Meaningful comparison

There is a lot of perspective and personal preference that goes on in selecting what gets included and excluded from savings rate calculations. Comparing your own savings rate with that reported by others, without first reconciling the underlying methodologies used, is a fool’s errand.

Analysing savings rate

The real story is told by the underlying numbers. Consider some key questions:

  • Are you lifestyle costs being partially/fully funded by your investment income? This could be a sign that you are living beyond your means… or a sign that you are nearing financial independence!
  • How has the composition of your income changed over the year? The composition of your expenses?
  • Financial Independence is the point at which your passive income covers your lifestyle costs. Are you getting closer or further away from this goal?

You may discover that your lifestyle costs are under control, but your investments are haemorrhaging money.

It is possible you are frugaling yourself into a corner, and can afford to loosen the purse strings and increase your family’s happy factor without significantly adding to your risk or adversely impacting your timescales.

Cash flow

A third lens of analysis that everyone should use, but few people actually do, is monitoring their cashflows.

The previous two metrics looked at what you have and where it came from. Cash flow is concerned with the question of when.

Many financial “emergencies” are really just piss poor management of cash flow, resulting in people being caught short when large expenditures land. A case in point being the alarming regularity with which Christmas or summer holidays seem to take many people by surprise each year!

As a business owner, and somebody who chooses to follow a seasonal working pattern, my own earnings pattern can be very uneven.

Some months there are multiple inflows arriving to fatten my piggy bank. Other months it can feel like I am steadily sinking, like a ship’s captain who has a hole in the bottom of his boat.

Understanding when income is due in, and when expenses are due to flow out, is key to financial survival.

The better you are at managing cashflow, the smoother the ride you will enjoy.

Wishful thinking

Monitoring cash flow also eliminates much of the wishful thinking that creeps into the net worth and savings rate equations.

For the purposes of cash flow analysis things like: tax relief, taxes deducted at source, unrealised capital gains, and inflated asset prices don’t exist.

Capital gains may make you rich, but cash flow makes you feel rich.

Analysing cash flow

Consider the following questions:

  • Are there periods when your income (from all sources) varies significantly from the norm? Examples may include: semi-annual dividend payments, annual bonuses, and tax refunds.
  • Similarly, are some months significantly more expensive than others? Examples may include: insurance premiums, tax bills, and seasonal utility bills.
  • What level of contingency fund do you need to maintain so that your head stays above water throughout the whole year?
  • Do you own assets that are net consumers (as opposed to producers) of cash? If so, do the realistic long-term prospects of that asset warrant bleeding cash to own it?

You may be subsidising the living costs of your tenants, or propping up a zombie business.

Alternatively you may be indulging in holiday homes you seldom visit, or driving clunker cars that are really expensive money pits.

Own your accountability

The exercise of calculating our net worth, saving rate, and cash flow reveal some interesting highlights from our financial journey throughout the year.

Analysis of what is going on beneath transforms those headline figures from interesting to relevant.

This analysis provides us with the opportunity to understand why the figures changed.

To learn from our mistakes.

To make well-informed decisions in the future.

But only if we listen to the numbers, and genuinely hear what they have to say.

And only if we don’t lie to ourselves, if we own the outcomes, and if we accept our accountability.

Why lie, when you can get away with the truth?

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10 Comments

  1. GentlemansFamilyFinances 22 December 2018

    Very good read.
    I agree with the emergency = poor cash flow planning.
    The recent outrage about the high cost of overdrafts as well as payday loans is symptomatic of it being the norm to think that people have zero personal accountability.

    For emergencies or lump sum items – car repair, a broken washing machine or to pay for Christmas- these are entirely predictable and sensible people plan – or you could of course insure but that’s often a rip off.

    On assets:
    I have my house valued at what i bought it plus or minus the change in the local house price as per the RoS.
    I do take that with a pinch of salt and i make no account for the new kitchen or fireplaces wr pit in – that money is gone.

    • {in·deed·a·bly} 22 December 2018

      Thanks GFF, glad you enjoyed it.

      We may not be able to predict exactly what will need maintenance/replacement, but we can be certain that some things every year definitely will!

      Personally I maintain a contingency fund, which is essentially a float that I dip into and top up as cash flow requires or allows. It is large enough to cover my lifestyle costs for several months, which serves to smooth out the rollercoaster ride that is my lumpy cash flow profile.

      Good call on considering cosmetic renovations to be sunk costs. My view is the vast majority of the price a property will fetch on the open market is down to location and size. A pretty finish, big bath, or shiny fireplace look good and probably help make a property easier to sell, but in my experience seldom materially influence the sale price.

      On the other hand adding rooms, subdividing, re-zoning, or gaining planning approach all can… but only when those anticipated improvements aren’t already priced into the buying price!

  2. [HCF] 22 December 2018

    Thanks for the detailed explanation!

    As the reader who wrote those lines, I can confirm that you got it right how I meant it. From the numbers perspective, 100€ is not a fortune, it is not chump change, it is just 100€.

    My statistics teacher used to say that statistics is beautiful because we could prove with it whatever we want. Numbers are just numbers, cold, hard, and dead. The meaning and the interpretation is what WE add to them and when doing so we are better keeping your points in mind.

    There is much to think about and many traps to fall for. In my finances, I try to apply an ASAP methodology. As Simple As Possible. This helps to see a clearer picture.

    • {in·deed·a·bly} 23 December 2018

      Thanks HCF.

      Generally I agree that simple answers are usually the best ones.

      When it comes to measuring your financial progress however, we must be careful not to gloss over inconvenient truths in the name of simplicity.

      It can be all too easy to cherry pick the options that make us look the best initially, then over time conveniently forget that the measures we are diligently tracking exclude or smooth away many of the hidden nasties that are all too real.

  3. Nick @ TotalBalance.blog 23 December 2018

    ASAP. I like that. We have a similar expression in IT: KISS. Keep It Simple, Stupid!

    I’ve yet to try and calculate my total net worth, based on some of the most commonly used formulas in the community. I agree that people tend to pick whatever methology that makes their net worth look “the best”. I don’t include my house equity or my pension, and I don’t count “future expected cash” in my current “total FIRE balance”. But that’s mainly just because of KISS 😉

    I am however now trying to figure out, how I prefer to pay the tax on my crowdlending interests in the future. If I stick to my “cash in hand” methology, I will pay it at year end, when I have the precise numbers from the years yield.
    But which money do I actually use to pay the tax? Do I withhold xx% of my interest, and stop re-investing my dividends in June/August or something?

    If I do it like the tax-man prefer, I will try and “guess” my yearly gains when the year start, and thus spread my tax payments out over the entire year. But this means that I will get less money in my hand each month. It’s a tough one. Luckily I’m not making that much on crowdlending yet, so it’s still a fairly small amount. – But obviously, I plan to increase it over time..

    • {in·deed·a·bly} 23 December 2018

      The provisional tax question can be a tricky one Nick. .

      The certainty is you will need to find some money to pay some tax at some point.

      The most conservative way to do that is set aside the tax due on each income receipt. That way you have it for certain. An important consideration here is that this money belongs to the tax man not to you… you are merely looking after it until you hand it over!

      A riskier approach is to have a good understanding of your cashflows over the course of the year. Armed with this you could continue to reinvest most of the year, but earmark certain cash flows (for example those in the month or two before the tax is due) to cover the tax bill.

      The additional risk of this approach stems from the reliance upon nothing material changing in your cashflow projections (e.g. losing a job, having an investment property burn down, or a company you hold dividend paying shares in going out of business).

      Another option is to utilise your contingency fund for this, but it does require ensuring you have a reliable (hopefully automated) means of replenishing that fund.

      One challenge to your thinking on excluding your pension holdings from your sums: If you FIRE, then your accessible wealth would need to support you entirely until pension eligibility age.

      After that your pension will contribute towards covering your lifestyle costs, meaning your pre-pension accessible wealth no longer needs to carry the load on its own. That reduces the amount of accessible pre-pension wealth you need to squirrel away, potentially speeding up your timescales.

      A similar story exists for access to any state pension benefits you may be entitled to.

      Food for thought.

  4. PendleWitch 28 December 2018

    Indeedably, sometimes it’s more comforting to tell ourselves little white lies. You’re trying to make us rational 100% of the time, and it’s not right! 😉

    I do include house equity in my calcs, accepting I could realise 50% of that if we headed back up north. If we stayed down south, then no. I would need some probabilities in my spreadsheet to capture that though and that’s a step too far for me!

  5. thefirestartercouk 4 February 2019

    You make some very good points here!

    I tried evaluating “my” investment performance one year and although it was quite interesting learning the process on how unitise my portfolio etc, I didn’t really see the point in the actual numbers that came out of it. I don’t know enough about investing to change anything about what I was doing anyway so it was more of a “oh look at that number, great” type of thing. So I haven’t done it since. I prefer to focus on things that I can at least sort of control such as savings rate and so on for my yearly reviews. Although admittedly there is still a fair bit of blame shifting on the expenses side of things… haha 🙂

    The first observation about people not caring about things they don’t own has always bothered me about human nature. I guess I was probably like that as a child because children don’t own much stuff and so don’t have much idea about what it’s like to have something you own ruined, but once I became an adult the fact that (it seems to me) like 95% of other adults still act like that really quite shocking. I’m not talking about people in poverty here who maybe don’t own anything/much and can be somewhat forgiven for “not giving a sh!t” about that sort of thing, I’m talking about literally people at my own office who are relatively wealthy, many own their own homes etc…. but who still treat the office toilets like some cess pit hole in the ground they will never see again… it absolutely baffles me the state of those toilets sometimes. They would never leave their own toilet like that so why the one at the office, just because they don’t own it and are not in charge of having to clean it up!?!??! Yuk! But there are plenty of other examples as you have given in the article and many more besides….

What say you?

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