Maybe you want to live free from money stress and anxiety. Or, perhaps you’re like me, aggressively investing to grow wealth.
Money measurements (metrics) provide feedback. You can define areas that need change, and you can see where you are doing well.
Metrics set you up to improve your personal finance game. Let’s go through em. They are listed in order of importance.
1. After-Tax Savings Rate
Your after-tax savings rate measures the gap between what you earn and what you spend. It’s the fraction of your after-tax (disposable) income that you save.
Your savings rate is the #1 factor when it comes to building wealth. I discuss this more in this post.
Your savings rate determines:
- How quickly you can pay down consumer debt.
- How fast you can build an emergency fund.
- How aggressively you can invest to grow wealth.
- When you will reach Financial Independence.
It is important to focus your limited energy on things you can control. Otherwise, you are wasting time and energy. Your savings rate is often 100% within your control.
Your Savings Rate and Financial Independence
Your savings rate determines how quickly you can pay down debt and build an emergency fund. It is the single most important metric that determines the time needed to reach Financial Independence (FI).
When you reach FI, your investment income will cover your lifestyle expenses. You no longer need to rely on traditional work to earn money.
How to Find Your Savings Rate
You need to understand two numbers:
- Your expenses; and
- Your after-tax income.
Savings Rate = (Expenses)/(After-tax Income)*100
Use the expense audit and budget tool (button below) to calculate your savings rate.
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2. Your Expenses
You can’t grow wealth until you can control expenses. Without expense management, expenses will naturally creep to match your income, even if you make $900,000 per year.
This is called lifestyle creep. It is common.
You want to track every penny on a monthly basis, do you? Most of us fail at this traditional budget where we track everything. Instead, consider paying yourself first using forced savings.
I use this expense audit tool to audit my expenses every two months. You can read more about the expense audit in this post.
Benefits of expense auditing include:
- Understanding essential expenses helps you properly size your emergency fund.
- Identifying where spending is misaligned with your values.
- Helps identify problem areas. It’s hard to solve a problem if you don’t know it exists.
You may be surprised by the amount you spend on drinks, groceries, or dining out.
Large Infrequent Expenses
Some expenses come unexpectedly, like home and car maintenance. You can still plan for these expenses.
For example, home maintenance can be estimated at 1% of the home value every year, while auto maintenance costs be estimated with Edmunds Total Cost of Ownership calculator.
3. Your Net Worth
Net-worth is your measure of financial wealth. It is the difference between what you own and what you owe.
Net Worth = Total Assets – Total Liabilities
Assets
Assets are things that you own. How your wealth is distributed among these asset categories matters. The three categories are:
- Investment Assets. Stocks, Bonds, REITs and rental properties.
- Use Assets. Items that you “use” to maintain lifestyle.
- Monetary Assets. Physical cash, money in a chequing or savings account, or money in a money market fund.
Liabilities
Your liabilities are your debts – money owed to others. Examples include student loan debt, a mortgage, line of credit, a credit card balance and outstanding bills.
Net Worth Location Matters
The location of your assets influences the direction of your net worth over time.
A concentration of net-worth in depreciating use assets will result in a plateaued or declining net worth. Although stable, net-worth held as cash will erode to inflation over time.
Wealth concentrated in investment assets will grow exponentially over time while generating cashflow. Double whammy.
4. After-Tax Income
Someone making $100,000 per year in Ontario does not have $100,000/yr to spend. Instead, $72,870 is remaining after-tax. It is that amount that can be used to spend, save or invest.
After-tax income is the amount available to spend, save and invest. Financial decisions should be based on after-tax income.
I do not control provincial and federal tax rates and neither do you. But we are 100% in control of our after-tax income.
In Canada, we can subtract the following from our pre-tax income:
- Federal and provincial tax;
- Canadian Pension Plan (CPP) deductions; and
- Employment Insurance (EI) deductions.
You can find after-tax income by using an income tax calculator like this one from intuit turbo tax.
Income Terminology
Your after-tax income is also called disposable income, not to be confused with discretionary income. I don’t like to use these terms. They are confusing.
Your discretionary income is the amount left over after you pay for essentials such as shelter, transport, food and clothing. Now you can use your “discretion” to spend the rest on whatever you please. I elect to invest most of my discretionary income.
5. Emergency Fund Target Size
Your emergency fund size is unique to you and your circumstances.
A guideline for emergency fund size is that it should equate to 3-6 months of essential expenses. Such essentials include shelter, food, transport, and clothing.
Going to a festival or going on vacation is not an emergency.
Emergency Fund Sizing Factors
- Home maintenance costs – can be estimated at 1% of the home value per year.
- Income stability – You’ll need a larger emergency fund if you are susceptible to job loss.
- How long it would take to find a new job.
- Whether you have a working spouse.
- Your unique willingness to take on risk.
6. TFSA Remaining Contribution Room
The Canadian Revenue Agency (CRA) sets an annual limit on the amount of money you can put into your TFSA. Your remaining TFSA contribution room is what matters. Don’t overcontribute – you’ll be hit with a fine equal to 1% of the overage per month.
So, knowing your remaining contribution room is especially important if you are close to maxing out your TFSA. You can find your remaining total TFSA contribution on your CRA My Account.
Be careful, the CRA does not capture any TFSA contributions made in the current year. Check out the TFSA contribution room calculator to track your real-time contribution room, and estimate future TFSA account value based on investment growth.
Your TFSA room represents an opportunity to grow tax-free wealth through investing. The TFSA does not provide utility unless you invest the money in the account. For more, learn How The TFSA Works.
7. RRSP Deduction Limit
The RRSP deduction limit is the total amount you can contribute to the RRSP and “deduct” from your taxable income. It is based on RRSP room gained in the current year, plus any unused room from prior years. Your RRSP deduction limit can be found on your CRA My Account.
You can use the RRSP to invest pre-tax income, and shelter it from taxes on capital gains and dividends.
Further, contributions to the RRSP allow you to make use of the Home Buyers’ Plan (HBP) and the Lifelong Learning Plan. The HBP allows first-time home-buyers to withdraw $35,000 for a down payment on a first home.
8. Marginal Tax Rate
Your marginal tax rate tells you how much tax you pay on each extra dollar earned. It also determines how much tax you will pay on investment income in a taxable account. Your marginal tax rate depends on two factors:
- Your total taxable income; and
- The province you live in.
Combined Marginal Tax Rate
You pay two types of income tax – federal and provincial. To keep it simple, you can find your “combined” federal and provincial tax brackets at taxtips.ca.
Check out the tax rate in your highest combined tax bracket. That’s your “marginal rate”. Alternatively, you can punch your income into a tax calculator such as this one from turbo tax. It will spit out your marginal rate.
Increasing Income Does Not Reduce Your After-Tax Income
This is a common misconception. Earning extra income will increase your marginal tax rate if you earn enough to push you into a higher tax bracket. In this case, a larger fraction of each extra dollar earned will go to uncle Sam.
You will always have more after-tax income if you increase pre-tax income.
Your Marginal Rate and Taxes on Investment Income
Once your TFSA and RRSP are maxed, it is time to invest in a taxable account. Here you will pay taxes on investment income.
Now you care about tax rates on interest income, capital gains income and dividend income. Tax rates for the three types of investment income depend on your marginal tax rate.
I aim to maximize after-tax wealth. This requires an understanding of taxes and tax-sheltered accounts. You can learn more in this post – Understand Taxes for Investing: A Guide for Canadian Beginners.