applied personal analytics measuring financial solvency and financial fitnessLately, I have been thinking about scientifically sound approach to measuring personal financial fitness. By financial fitness, I mean both financial solvency and proficiency: the degree to which person is financially prepared for the retirement and unforeseeable events in the nearest future (e.g.,sickness, loss of job, etc.), and is managing finances efficiently. Considering that almost one third of Americans do not save or contribute to 401k enough, and almost two third do not believe they will have enough money to live comfortable after they retire, financial fitness should be regarded just as important as physical and mental health (in fact, health and finances are often correlated: financial problems are often cited as a main cause of stress). And just like mental and physical health, financial health should be measured and monitored. But is there an objective indicator of how financially fit are you? In this post, I propose a new, quantified-self approach to measuring financial fitness.

But first, let’s take a brief look at two metrics that are often currently used to assess someone’s financial health: the net worth and credit score. In my personal opinion, using these numbers to measure financial health would be misleading. The net worth, defined as total assets minus liabilities, captures only current state of person’s financial affairs; it does not reflect likelihood of retiring comfortably, or financial “savviness” of person. The second metric, FICO’s credit score, as well as its twin, Vanguard Score, or their more recent clones, e-scores, are not better. Something must be fundamentally wrong about the model under which engagement in activities like taking a loan or mortgage, or signing up for more credit cards, yields a higher score. The truth is, these scoring models regard us not as individuals but as “consumers”, with the primary objective to evaluate our current discretionary income and propensity to continue borrowing and spending money in the future.

But what about metric that would reflect your ability to diversify investments, save money, and live responsibly? Alas, such metric does not exist yet. And I think that now is a perfect time to develop one. Imagine a system that would take into consideration various aspects of your personal finances such as:

  • monthly savings rates
  • contributions to (401)k and other retirement plans
  • ownership of real estate and cars
  • passive income sources like profits from investment real estate, or from trading stocks
  • interest from CDs, saving accounts, stocks, mutual funds
  • lifestyle inflation rates (living beyond your means)
  • inconspicuous consumption

and combines them in one single score that reflects both your financial “savviness” and potential to retire with a desired “nest egg”. Each of these factors would have a positive ((e.g., saving at least 25% of your monthly paycheck, or keeping your rent under 35% of your monthly pay), or negative (e.g., spending more money on eating out versus groceries, or owning a car in the area with well developed public transportation) negative impact on the score, and each factor would have a different weight. The score is computed in such a way that it discourages living beyond your means, and encourages more careful and informed management of personal finances.

Such scoring system should be offered on opt-in basis, as opposed to FICO or e-scores. It may be either norm-referenced (you are compared to other people nationwide, or locally, similar to credit scores) or criterion-referenced (score is computed based on your desired amount for retirement, and is used only to measure personal progress). And, of course, it could be implemented in Mint, Yodlee or other financial tracking software.

What do you think?

(image credit: Outside Ordinary blog)

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