A while back I attended a FranklinCovery “4 Disciplines of Execution” workshop for my work. It’s a brand new training course and our company, being located in Utah close to FranklinCovey, was chosen as a test group. They brought up some very interesting points about the most important measures for determining success in reaching your goals. As I went through the training I could help think how these concepts apply to personal finances.
Lead vs. Lag indicators
One of the major distinctions they made in the training was between lead and lag indicators. These are measurements you can track that help you achieve your goals. A lead indicator is something that can be tracked and acted upon in the moment and that predicts the outcome. A lag indicator is something that can only be tracked after a result has been achieved. Lag indicators don’t predict an outcome, but rather show the results of an outcome that has already occurred.
The main point here is that a lead indicator is also something you can control in the moment whereas a lag measure is something you can’t control because it’s already happened.
Lead vs. Lag example
Confusing? Here’s an example. Let’s say your son has a goal to save $5 for a toy at the end of the month. In this situation a lag indicator would be how much he saved last month. It already happened and can’t be changed. It also won’t predict how much he’s going to save this month. In other words, it can’t be acted upon. On the other hand a lead indicator could be how much he puts in his piggy bank every day. This is a measurable indicator that your son can influence and act upon and will predict how much he has saved at the end of the month.
As you can see from this example, it’s important for us to identify the lead indicators for reaching a goal because they help us act and to achieve the goal.
Applying lead and lag indicators to personal finance
So how does this apply to personal finance? I often see people using lag indicators to try and predict future performance within their finances. For example, how many of you have wanted to figure out what you are going to spend next month on groceries by looking at expenses from last month? We’ve all done it and yet that is a lag measure. How much you spent last month may have nothing to do with the expenses you’ll incur next month. Further, you can’t act to change what you spent last month. Looking at your finances this way is almost useless in helping you curb future behavior.
Instead, what are some lead measures that could help you predict next month’s grocery spending? What measures will help you achieve a goal of spending a certain amount and no more? There actually could be many different lead measures, but let me suggest a few possibilities.
Lead measure examples
One lead measure could be how many times you go to the store every week. By going to the grocery store less you may spend less which would help predict how much you’ll spend by the end of the month. This probably wouldn’t be the most effective lead indicator, but it’s a start.
Another, slightly better lead measure could be creating a spending plan for your groceries. By outlining how much you’re going to spend on what, you can predict what the total expense will be and such a plan will influence your behavior. While this is a much more effective lead measure and will be more highly predictive of the final outcome, it would require a lot of time and work.
Probably my favorite lead indicator for how much you’ll spend on groceries next month is how much cash you take out to spend on groceries. Of course, this assumes you are exclusively on a cash basis for groceries and that you wouldn’t purchase groceries on a credit card. If you take out $400 for groceries and only spend that cash, you have a perfect lead measure that predicts you will spend $400. Cash serves as the perfect feedback loop. Once the cash is gone, it’s gone. Cash is also a great lead indicator because it can influence your behavior in the moment. If the cash is running low, you may reconsider purchases or decide to purchase some items next month if you don’t really need them yet.
Don’t be deceived by “quick lags”
In contrast, let’s look at using credit cards to measure spending. Many people would consider using credit cards to be a lead indicator because they can look up their account at any time and see what they’ve spent. However, using a credit card in this manner is NOT a lead indicator. Instead it’s what they call a “quick lag.” A quick lag is something that can seem like a lead indicator, but has already occurred and can’t be influenced.
The best comparison is someone trying to lose weight. It may seem like weighing yourself daily is a lead indicator, but it’s actually a “quick lag.” Why? When you weigh yourself, you can’t immediately change the results. There is nothing actionable about weighing yourself. Your weight is the result of decisions you’ve already made and can no longer control.
Looking at your credit card spending at the end of every day is the same way. You can’t go back and change what you spent. Your spending is a lag indicator showing what has already happened and it can no longer be acted upon.
Now I will agree that if someone were to look up their account before every purchase to see how much they’d spent in a certain budget category, it could be a lead measure and could influence behavior in the moment. But that is not a common behavior nor is someone likely to go through the hassle of doing so.
How to create your own lead indicators
So how do you create your own lead indicators to help you reach your financial goals? There’s no one clear answer to this question. Identifying lead indicators can take some creativity and can be a fun process. Here are some guidelines that will help.
Characteristics of lead indicators include the following:
- they are forward-looking and predict future performance
- they predict or contribute directly to achieving a goal
- they can be influenced or changed in the given moment
Characteristics of lag indicators include the following:
- they are backword-looking and measure something that has already occurred
- they can not be changed or influenced
Try looking at the measures you use to control your finances and see if they are lag or lead indicators. Can you change or improve them to be more effective? What behaviors or actions are predictive of how much you spend? How much you save? By re-evaluating your system within the framework of lead and lag indicators, you may have some useful insights that will help you achieve your goals more quickly and easily.
What measurements do you use? Leave a comment and share what measures have worked best for you.
Posted in Finances, Personal Finance |