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Measures That Matter

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The best way for most people in America to increase their revenue is to get paid more by their employers. There are several aspects to this that have already been discussed. An important additional concept is bench-marking.

Bench-marking compensation means you have a simple way to calculate how far you have come and how far you need to go to reach your goals. It is important not to let expenses increase at a rate faster than income. Your cash flow statement includes both what comes in and what goes out. The idea is to show and continual and growing profit, just the way successful companies do, using the formula:

Income – Expense = Profit

I not only want the P quantity to be always increasing, I want it to be increasing at a faster rate, year over year than E. This gives me the ability to predict profits, not just to know where they have been. Profit is what I can invest so that I can achieve financial security. It is not what I need to live on or meet obligations. If I spend my profit on luxuries it will never help me achieve financial security. In essence, I converted it into expense and my profit is zero if I don’t have income producing assets to show for it. If I mazimize investment and build assets over time I will get to the point where I won’t have to work for wages any more, though I may choose to continue to do so.  I will talk about investment and passive income separately.

The other numbers I need to benchmark are in my statement of net worth

Assets – Liabilities = Net Worth

Net worth is what I own minus what I owe. As before, if my debt is growing faster than my pool of assets I can forecast a problem, even if my net worth continues to grow.

As an aside, I have been consistently amazed at how many people either don’t know their net worth or mistakenly believe that what they owe PLUS what they own is their net worth because, as Dick Cheney said, deficits don’t matter.  This nonsense has doomed the full faith and credit of the USA and the hyper-leveraged citizens who are its back stop.

To get a gut check on where I stand I use an old trick called the rule of 72. The Rule of 72 helps me to do a quick comparison of compound growth rates. It is useful for evaluating any type of cash flow – investment or salary based. It goes like this:

Divide the number 72 by the annual percentage growth as a whole number. The quotient is the number of years it will take for the principal to double in value.

This is generally used when you have a lump sum to invest and want to evaluate different options. If you pretend what you earned last year is your principle, the year-to-year change can be expressed as a percentage and you can evaluate growth in salary. This method is crude but effective and always available.

EXAMPLE  If I can average 6% salary increase every year, how long will it take before I am making twice as much as I am now?

ANSWER: 72/6=12 years.

If I can increase the average salary increase to 8% the time it will take to double goes down to nine years.

Why is this important? Because If I have set a goal of retiring in ten years when I am making twice what I am making now I need to average increases of 7.2% per year. If I get less than that for more than a couple of years I probably won’t make my goal so I need to get on the stick or change my goal.

If I doubled my income every six years in the past and I want to do that again I need to keep getting increases at a rate of 12% per year. This may or may not be realistic given economic or other factors. If I know I have doubled my expense every five years then I have a problem. I may be making a nice income now and may be able to borrow a lot from a banker but ultimately I am falling further behind. This is very simple math and there is no escaping this reality. Unfortunately, looked at this way a large number of American households are technically insolvent and they don’t even know it.

It is lunacy to expect that I will be able to retire at a standard of living that never becomes fixed. If I fix my required standard of living at what I made in my best year amidst twenty years of fluctuating income then I can be pretty sure I will be hustling until I drop dead. This may be OK with me, but it increases the risk that I will leave nothing but my toys and memories for my family (assuming I was ever there). If, on the other hand, I can fix my required standard of living and the expenses it requires at some point before I hit my peak earnings years (the last decade and ½ before retirement) then I have a better chance. I can now focus on investing in inflation and shock resistant assets while controlling expenses. All I need is relatively stable and predictable income to reach my goal because my income will significantly exceed my expense during my entire peak earning years.

By vitruvius1

Andrew Talbot

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