I’m a big fan of the DIKW model or DIKW pyramid. It is a method that aims to explain the ways we move from Data to Information, Knowledge, and Wisdom with a component of actions and decisions. Simply put, it’s a model to look at various ways of extracting insights and value from all sort of data. It’s often depicted as a hierarchical model in the shape of the pyramid and also known as the data-information-knowledge-wisdom hierarchy.

If you pay attention to the pyramid, you might be tempted to think that it all starts with the data. Wrong. The first step is to explicitly state the question you’re trying to answer so that you can gather the data that is relevant to such question. You might have data readily available, or you might not have any data at all but that’s ok. Let the question(s) drive the process and then start taking advantage of the DIKW model.

I consider myself to be data-driven and according to the StrengthFinder test, analytical is sitting at the top. Even though this is a handy skill set for someone pursuing Financial Independence, I can see how it could backfire if not handled properly. In short, my inquisitive nature tends to rub people the wrong way. It is certainly not my intent to cause any friction; however, my data and factual-driven nature often lead to causing stress in the system. Intentionality and self-awareness certainly help but you can only adjust so much.

I tend to hold back from giving any advice but when I do, I find myself asking for data and information to influence my suggestions. In general, the way I ask questions has improved but sometimes my perception is they’re still not well received. This is especially true when I sense a decision has already been made and the expectation is for me to simply comply. I’m sorry but that’s just not the way I operate. This is definitely an area for improvement; however, I have to remain true to who I am in my core.

Why am I saying all these things in a post that’s about savings rate? Well, if you want to be able to answer the questions about your savings rate and others that usually come up in personal finance, you absolutely need to gather relevant data.

Tracking your income and expenses is by far the most important thing you can do to truly asses your financial state. Making decisions to influence your future should consider where you are and where you have been, otherwise, you could be at risk of implementing optimization strategies that are blind to past experiences that could ultimately lead to suboptimal results.

This next quote is also one of my favorites. It should provide context in case you’re freaking out about data gathering.

Today, tracking your expenses is super easy. There are many tools out there but in my opinion, Personal Capital does an outstanding job. It’s definitely not a perfect solution, as neither are others in this space, but what I can tell you is that all these tools are way better than the alternative, i.e do nothing and assume life is good.

I recently finished performing a look back at 2018 to calculate our annual savings rate.  I also wanted to know how well we did in paying ourselves first and putting money aside in other buckets included in our financial money map. This process took approximately 2 hours; however, this seems like a good trade off if in the end, you can use the results to understand your performance in 365 days of the year.

One of the things that I normally do is that at the end of each month I’d go into Personal Capital and spend 10-15 minutes categorizing all expenses and making sure they are in line with my expectations. This has helped identify cases where fixed expenses have gone up incorrectly or if fees have been charged to any of my accounts.

Budgeting is a good tool to track performance. We used to budget but today it just doesn’t add a ton of value. For us, automation coupled with Personal Capital is more than enough. As long as I can keep track of our net worth and check our monthly expenses then I’m good. Remember that simplification is critical in personal finance and sometimes less is more.

Personal capital appeared on my radar in 2015 and since then, tracking our annual income and expenses has become the norm. It takes minimal time to adjust expense and income categories but once it’s all set and done, their algorithm learns and future work tends to be minimal. The next step is to download all the information as a .csv file (I use Excel), do a little bit of data post-processing and simple math. I hope this last part doesn’t scare you off and stops you from reading the rest of this post.

Personal Capital calculates your monthly cash flow automatically but in my opinion, automating the calculation of an individual’s savings rate, monthly or annually, could be a great addition to the tool. I’m not really sure how they could make that work for individuals that have a mortgage. Point being that the principal part of your mortgage payment should not be considered an expense (at least in my opinion). If Personal Capital is able to figure that out then that’s it. No more data munging in excel for this guy :).

Once you have all the numbers, calculating your savings rate is straightforward. The way I do it is by using the following equation:

After plugging in my numbers, my savings rate for 2018 was 60%.

At face value, it seems like we did a hell of a job, especially when you compare this number to past years; however, in full disclosure, I sold a big chunk of company stock that brought in an extra five figures. If I remove that number then my savings rate sits at 38%. Not bad but I was hoping it would be higher.

Now let’s look at the main expense categories that contributed to my savings rate number, and more importantly, how do they compare to 2017. All numbers for each category are shown in percentages (%) as a function of total spending for the given year.

Mortgage:

This category remains my biggest spent (as expected) accounting for 28% of our annual expenses. This number includes principal and interest on our primary home as well as two rental properties. I don’t plan to accelerate mortgage payments in 2019 so everything should remain flat assuming I don’t acquire additional real estate.

Automotive:

I was caught off guard with having to replace the water pump on our SUV. From an expense standpoint, this event coupled with general maintenance represented 4% of our annual spent but the increase with respect to 2017 was 325%, ugh. I wish I could have timed paying for the water pump repair with my travel hacking strategy and the opening of a credit card; however, surprises and emergencies usually don’t give you too much of a heads up. After that hit, I was so pissed that I seriously thought about selling our SUV but after running the numbers it didn’t make sense financially. The risk of throwing away more money is still high but I hope I can manage until I say f..k it and proceed with selling it.

Groceries:

Groceries accounted for 10% of our annual expenses and honestly, I think we could have done better. We are still trying to figure out options to bring our number down but for now, the one thing we won’t do is to go cheap and start buying unhealthy food. Any tips?

Travel:

This is the only category I don’t mind seeing an increase YOY. It went up 10% compared to 2017. We got the companion pass at the beginning of 2018 and even though we didn’t use it as much as I wanted to, we traveled way more compared to 2017. I don’t want this number to necessarily go up. One of the benefits of travel hacking is traveling for free so my goal for 2019 is to do more smart traveling and trying to maintain our number flat if possible.

Restaurant

Definitely not happy with spending more eating outside. It was an increase of 97% with respect to 2017. It also accounted for 6% of our annual expenses which is just unacceptable. My wife and I certainly enjoy experiences and Denver has become quite the culinary scene. We won’t necessarily quit eating out but I think there are a couple of things we could do such as having lunch as opposed to dinner, taking advantage of happy hours, and others.

General Merchandise

Ugh. This category is all the stuff that we bought during the year. An increase of 354% with respect to 2017 and 8% of our annual expenses in 2018. I think we made some companies really happy but the two at the top are Target and Amazon. The one purchase I don’t regret is a road bike to ride the Colorado MS150.

These 6 categories represent ~63% of our annual expenses in 2018. Others include healthcare (4%) which went up with respect to 2017 and daycare (4%) that actually came down with our oldest switching classrooms and getting closer to Kindergarten. A car loan on our SUV accounted for an additional 4%.

Paying Yourself First

I cannot stress how important it is to pay yourself first. As a matter of fact, I have a post dedicated to it because to me this is something you have to do, period. Yes, I understand that every personal situation is different but if you’re intentional about the decisions you make I’m absolutely sure that you can make it happen.

I’ve been paying myself first for as long as I can remember; however, 2018 was my first year pulling the trigger on the mega backdoor Roth conversion. When I ran the numbers I came $1500 short of maximizing the Defined Contribution Limit that in 2018 was set at $55,000. The table below shows my numbers combining retirement savings in tax-deferred vehicles as well as brokerage accounts.

Final Thoughts

Start with asking yourself the following question: How am I doing today financially and can I do better?.

Past performance in the stock market should not be used to predict future performance but when it comes to improving your behaviors and the decisions you make in the future, your past should definitely be analyzed.

Once you have the Data, it is my hope you will let it Inform you so that you can turn it into Knowledge and Wisdom. Whether or not you decide to do something it’s entirely up to you. Estimating your savings rate is easy, so what are you waiting for.

Until next time … JJ