Set Your Financial Redlines

I learned the power of a flashing red light one night when I was flying home. My company had chartered a small prop plane for several executives and me.  With limited seats, I ended up in the copilot chair as we bounced around in some turbulent weather.

I don’t know anything about flying, but was relaxed until a red-light starting flashing on the dashboard. In a bizarre effort to assure me it was nothing to worry about the pilot pointed to it and said, “I don’t think that’s going to be a big deal. We should be all right.”

Three hours later we landed and I was a nervous mess after watching that red light blink the whole time. To this day I have no idea what that light meant, but I never forgot the power of a red light on the dashboard to focus my attention.

I applied that power of a dashboard in community banking. In that industry, it’s common to put prominent community members on the board who may be very accomplished in some field, but they may not know a lot about risk and finance.

To help a new director get comfortable contributing, it was very effective to put the most important financial factors on a color-coded dashboard. For even the rookie directors, it was easy for them to identify a risk indicator that needed explanation if it was yellow or red.

Personal Finance Dashboard to Focus our Attention

I’m not aware of financial dashboards being widely used in personal finance. But I think they should be. In this post I want to illustrate what a financial dashboard might look like for someone close to, or already in, retirement. However, the concept could be customized for other ages with a little thought of what’s important to monitor with finances at any age.

I’ll explore in this post four metrics you could use to evaluate the current status of your retirement dashboard. We’ll look at others in the next post.

Financial Independence

Rationale: The overriding financial goal for many people is to achieve the freedom that comes from having enough to live without a paycheck. A widely accepted rule of thumb states that a retiree should be able to withdraw 4% of his/her financial assets every year for 30 years without running out of money if invested in 50% stocks and 50% bonds. As interest rates have plunged, many advisors have suggested a 3% rate.  A motivated saver may use this this dashboard to estimate how close they are to never needing a paycheck again.

Green: When pensions, Social Security (SS) and 3% of financial assets cover all annual living expenses.

Yellow: When pensions, SS and 4-5% of financial assets are needed to cover living expenses.

Red: When pensions, SS and greater than 5% of financial assets are needed to cover living expenses.

Actions to Improve: If you are anxious to speed up the date you can leave your job behind, you can attack the problem two ways. First is to cut expenses. There are many super savers who save over 30% of their income to speed up the timeline. That is sometimes easier than the second approach which is to increase your income and savings while holding expenses steady. Of course, a little of both works too.

Debt

Rationale: Going into retirement debt free lowers the financial independence threshold because you have no monthly debt to service. Most retirees want to go into retirement debt free. However, there is a valid argument to avoid paying off mortgage debt. It is the lowest cost and it is a hedge against rising inflation in retirement as the debt will be retired with devalued dollars. While I agree with the logic, I personally prefer the no debt entry into retirement.

Green: Debt free.

Yellow: Mortgage debt only.

Red: Any credit card debt along with other debt.

Actions to improve dashboard: Some form of the debt snowball can be effective in motivation. The technique is to pay off the debt with the lowest balance first to gain psychological momentum with a win. Then apply the payment from the paid off debt to the next lowest balance and repeat until debt free. An alternative is to pay off the highest interest debt first no matter the balance and repeat.

Generosity

Rationale: The true wealth we possess from living with a generous spirit toward those in need around us can be externally calculated to some extent.  Clearly there are other ways to be generous besides giving money, but it can be a good indicator. This quantitative test is easily done around tax time.

Green: Donations exceed 10% of income annually.

Yellow: Donations usually are between 5% and 10% of income.

Red: Donations are less than 5% of income.

Actions to improve: Getting involved in a church or nonprofit where we can come alongside those in need is usually a way to motivate our generous spirit.  

Diversification of Investments

Rationale: Safety comes in diversification of assets. As we leave a paycheck behind, diversification becomes more important as we no longer have time to make up for a devastating loss in our financial assets. Diversification is normally the best way to address this risk.

Green: Less than 5% of financial assets in one investment. Over 90% of assets in broadly diversified index funds mixed between stocks, bonds and liquid money market funds.  

Yellow: Up to 10% of financial assets in one stock. Less than 90% of assets in broadly diversified index funds mixed between stocks, bonds and liquid money market funds.

Red: The majority of financial assets in one company.

Actions to improve: Calculate what percent of your assets are in one asset class every year. As concentration grows in one area, rebalance to preset percentages. If you are not familiar with this concept you should consult with an investment professional as you perform the review. The dashboard percentages are in my comfort range but may not be appropriate for your situation. A low-cost alternative is to invest in a Target Retirement Fund that will rebalance automatically.

Next time

I’ve got a few more dashboard indicators, but it’s time to hit the send button. But I am curious if SMWP readers might be willing to discuss your most important metrics you use to monitor your financial well-being.

We can compare notes next time when I finish the dashboard.

Joe Kesler

Smart Money with Purpose