Track Your Financial Goals with Four Key Measurements

Today’s Saturday Selection from The White Coat Investor gives you four key benchmarks to track while working to achieve your financial goals.

Whether you’re trying to get out debt, save up for a big purchase like a trip, house, or boat, or achieve financial independence, tracking these four key measurements will help you achieve those goals.

We wish you success in achieving whatever goals you’ve set! As always, this article originally appeared on The White Coat Investor.

 

Question: I am an emergency physician who recently completed residency. How can I make sure I am as successful in my finances as I am in my clinical practice?

 

Answer: Business expert H. James Harrington once said, “Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.”

As physicians, we have become intimately familiar, perhaps too familiar, with business-related metrics (eg, door-to-doctor time, physician satisfaction rating, and percentage of downcoded charts). There are also metrics for your financial life that can be measured and allow you to “keep score” in working toward your financial goals.

Of course, the purpose of keeping score is not to compare yourself to anybody else but to compare your performance from year to year and against your own financial goals. This article will discuss four of the most important measurements.

Track Your Financial Goals with Four Key Measurements

 

#1: Track Your Net Worth

 

Perhaps the most important measurement someone seeking financial success can monitor is net worth. Net worth is the sum total of all your assets minus the sum total of all your liabilities. Assets include bank accounts, retirement accounts, investments, home equity, and the cash value portion of life insurance. Liabilities are primarily debt, such as student loansmortgagesauto loans, and credit card debt.

Many financial professionals find it amazing that so many physicians have no idea how much they owe in student loans. It can be scary to add it all up, but it is hard to reach any reasonable financial goal if you don’t know your starting point.

Pour yourself a tall drink of your favorite beverage [PoF: You don’t have to ask twice!], sit down with all of your student loan paperwork, and actually add it all up and write it down. Chances are good that, if you have never done this, the total is quite a bit more than you think given the relatively high student loan interest rates.

Most physicians graduate from residency with a negative net worth due to high student loan burdens. One of their first financial goals should be to get back to a net worth of $0 as soon as possible. Many doctors find it more difficult to get to $0 than to go from $0 to $1 million in net worth!

 

 

see what i did there?

 

#2: Track Your Savings Rate

 

Another important financial metric is your savings rate. This is the percentage of money saved in a given year toward your long-term financial goals, such as retirement or college, divided by your gross income.

While there are many different ways to measure savings rate, because you’re “competing” only with yourself, it only matters that you are consistent with your method. I suggest you count retirement account contributions and other investments as well as paying down debt as “savings.” If you are unsure what to count as income, keep it simple and use your total income from your tax return. It can be found on Form 1040, line 22.

bankofamericaI generally recommend physicians save 20 percent of their gross income toward retirement. While 15 percent may be enough if you work long enough and don’t make too many investment mistakes, and 25 to 40 percent may be required for a very early retirement, 20 percent is a good starting place for most doctors.

However, 5 to 10 percent is almost surely going to be inadequate. Measure your savings rate each year, and if it is too low to reach your goals, find ways to boost it throughout the year.

[PoF: I recommend living on no more than half your takehome pay, which will be similar to WCI’s 25 to 40 percent of gross income, if you’re interested in achieving financial independence fairly quickly. Use my savings rate calculator to calculate your net and gross savings rates.]

#3: Track Your Tax Rates

 

I am often surprised to find that physicians have no idea how much they actually pay in taxes. There are really two tax rates worth keeping track of. The first is your effective income tax rate. To calculate this, add up your federal income tax, state income tax, and payroll tax, then divide that sum by your gross income.

For me, this number has varied quite a bit throughout my earning years. It was as low as 5 percent during my time in residency and the military, but in 2014 it was around 23 percent and by 2017 was over 30 percent. I

f you find your effective income tax rate is similarly high, it may be worthwhile to seek out ways to legally lower that burden, such as contributing more to tax-deferred retirement and health savings accounts, keeping better track of potential deductions, or moving to a state with a lower tax burden.

 

[PoF: Also do all you can to minimize tax drag and eliminate or minimize capital gains taxes in a taxable account.]

 

The second tax rate worth knowing is your marginal tax rate. This number is generally significantly higher than your effective tax rate. The easiest way to calculate it is using tax software upon finishing your taxes each year.

Simply add $1,000 of hypothetical income and see how much your tax bill rises. This year, my tax bill increased by $418 for that hypothetical $1,000, so my marginal tax rate in 2015 was 41.8 percent. The software accounts for federal income tax, state income tax, phase-outs, and even payroll taxes if you are self-employed.

Knowing your marginal tax rate is useful when making decisions about money, such as whether to invest in taxable bonds or tax-free (but lower-yielding) municipal bonds in a taxable account. It may also affect how many extra shifts you wish to work, knowing that 30 to 50 percent of every additional dollar you earn is going to taxes. Your marginal tax rate can be lowered using the same techniques used to lower your effective tax rate.

 

#4: Track Your Annualized Investment Return

 

Many investors have no idea what their investment returns are. That makes it very difficult to know if you are on track to reach your goals. It is best to calculate your returns on an after-expense, after-tax basis.

The most accurate way to calculate your investment return is using an internal rate of return (IRR) function in a spreadsheet or a financial calculator. The only data needed to do this are the amounts and dates of contributions and withdrawals (including any dividends not reinvested) to the account.

Since the contributions will not be regular, you will need to use a function called XIRR, or the internal rate of return with nonperiodic cash flows. This function provides an annualized rate of return as opposed to an average rate of return. It is important to know the difference since the only return you can spend is an annualized one.

 

[PoF: I love spreadsheets, and I’ve built a universal spreadsheet to help you track your portfolio, but frankly, it’s much easier to let someone else track your portfolio’s returns for you. I use Personal Capital, which will also help you with #1: Tracking Your Net Worth.]

 

By way of comparison, the average annual return of the S&P 500, with dividends reinvested, from the years 1927 through 2014 is 12.1 percent. However, the annualized return is just 10.1 percent.

This effect is due to the volatility of investment returns; in short, you need a 100 percent gain to make up for a 50 percent loss. The more volatile your investment returns, the greater the difference between your average returns and your annualized returns. A tutorial showing how to use the XIRR function to calculate your return can be found here.

Keeping score by calculating these simple financial metrics once a year can provide you with the knowledge and motivation you need to reach financial success.

 


Track your investments for free with Personal Capital. That's how I track the PoF portfolio.  

 

What do you think? Which metrics do you keep track of in your financial life and why? Comment below!

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9 comments

  • I couldn’t agree more. These four take some effort (&/or software) but are high-yield. It is amazing how many physicians can tell you 0/4.
    They track only gross income. A high top-line can make up for a lot of errors but not all of them. Too many assume they will end up rich somehow. Achieving your goals and freedom are too important to not be strategic.

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  • M

    I would replace item #4 (investment return) with spending–although one could reasonably argue spending is derived from #2 and #3.

    If the purpose of tracking something is control, spending is actionable while investment return is (mostly) not.

    • Excellent point. Tracking spending could easily be #1. It’s certainly more important than tracking your tax rate(s), which you don’t have a whole lot of control over, anyway.

      Cheers!
      -PoF

  • The great thing about following this system is as long as you keep your lifestyle inflation in check your net worth and savings rate should start skyrocketing as money come in from all sources will start self feeding the system and create money of its own (I called it the capital snowball on my blog). My savings rate because of this is now in the 70-80% range and still climbing as I have maintained a stable baseline lifestyle while the income streams keep rising.

  • Gasem

    What you actually need to know is contained in Personal Capital and Mint. Tracking your finances any other way is a waste of time. I just checked my personal capital account and since 1992 my portfolio has tracked the ideal portfolio like a mirror. I know my asset allocations and they are not based on a guess or the gaseous emission from some internet blog site, but on solid analytical data. I know precisely my portfolios risk (10.1%) and precisely my portfolios long term return (8.1%) My portfolio lives on the efficient frontier which means I don’t pay too much risk for my return. My portfolio is Monte Carlo tested so I have a very good idea how it will stand up to a poor sequence of return and whether or not I will die poor. I can control additions like my SS and my wife’s SS and those get added into the mix in the time frame I expect to take them. I can adjust real time my yearly spending as it occurs and understand the impact on portfolio longevity.

    Mint is how I track my spending and has reduced my spending dramatically because I have a much cleaner picture of where the money goes. I log into Mint, review my charges, download a monthly file into Excel and adjust for credits and special expenses (like the air conditioners I put in last month). I understand when an expensive month is likely to occur (July is car insurance biannual of $3000 and August is when yearly home insurance, flood insurance and my kids college expenses gets paid). This means those are bad months to plan for a trip to Europe. October on the other hand looks good for travel. Mint helps to accurately smooth out my budget bumpiness. These tools are available and free and up to date from a financial theory perspective. They update from your accounts automatically. Recommending 6th grade fractions to understand your portfolio when in depth state of the art data analysis is available for free, doesn’t make much sense to me.

    Managing your tax bite is important as well. I spend most of my finance time these days optimizing my taxes both present and future

  • Yeap, I think tracking your spending should be #1. Everyone needs to get their expense under control first.
    I guess if you’re tracking saving rate, then you’re already tracking spending. 20% is a good start, but I think you should strive for 50%. That’s a nice round number.

  • Excellent post! My favorite questions to ask docs are:
    What is your burn rate?
    What is your end game? Without knowing the above 4 it can be hard to answer these questions. I also agree with Gasem that Mint.com is worth the trouble to setup. Once the custom fids are set, I know my net worth, gross savings, burn rate and return on my investments including a rough estimate of my real estate. The best part comes from showing my wife and family the colorful graphs to motivate them to save even more.

  • jmac08

    PoF- can you expound upon the Personal Capital website? This is the first of heard of it. I read through their page, but it doesn’t mention charges for their services. I was hesitant to move forward when they wanted me to link in all my financial accounts. However, I would be interested in a service that would help with organization, helping me keep track of investment returns, etc… What do you use them for, and are there associated fees?

    • There are no fees for the investment tracking and analysis features. They do offer an advisory service, which I don’t use or recommend, which comes with an AUM (assets under management) fee. It was interesting to go through the spiel with one of their advisors to see what their recommendations were, and how they matched up with my portfolio.

      The security aspect is addressed well in this piece by Jim Wang at Wallet Hacks.

      I’ve been using Personal Capital for 3 to 4 years and have been very happy with it.

      Best,
      -PoF

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