As an engineer, I love to get data, analyze it, create models and based on my findings support decisions that influence the bottom line. This is all great; however, we usually get carried away and move into execution mode without spending the right amount of time defining and understanding the problem statement. As a result, time is wasted and lack of decisions lead to an overarching feeling of frustration.

Once we’re clear on what the research question is, the next step is to collect relevant data, perform exploratory data analysis and create a descriptive model(s). This model will describe the importance of the variables (predictors) included in the study and how they influence the outcome (response variable). This model might be good at explaining the observed variance (R2-adjusted) but might suck as a predictive one.

There are numerous predictive models that can solve the most complex problems; however, they can easily become black boxes that despite their performance, can be difficult to interpret and as result, may lead to lack of trust and buy-in. Personally, I’m of the opinion that you should start simple and increase complexity only if it can be justified.

We now have this awesome predictive model that we’ve checked for over-fitting, and that when compared to blind data, does a hell of a job providing an acceptable match. So what? have we solved the problem? not really, if your model does not support or influence decisions centered around the problem statement then you have not yet delivered value. If the opposite is true, then is game on.

Predictive models are powerful because they facilitate building prescriptive models that instead of telling you what happened and why they suggest what you should do based on an already optimized scenario!.

It is my hope that by now you see the analogy that exists between Data Analytics, Optimization, and Personal Finance.

This analogy does not imply one should take advantage of models that predict the behavior of the stock market so you can buy at a low and sell at a high (but wouldn’t that be great 🙂 ). Instead is about creating awareness around the variables that influence your finances and how each could be optimized to achieve your ultimate goal.

What Should Someone Optimize?

I’m a big fan of using the Question-Data-Information-Knowledge-Wisdom pyramid. As a matter of fact, I use it this type of philosophy not only at work but in all aspects of my life.

The reason is simple … You can’t think of optimization before identifying and more importantly, understanding the key performance drivers influencing that which you intend to optimize.

Whether you want to increase your annual savings rate, net worth or simply lower your monthly expenses, the reality is you need to spend time with the data and embrace what it is trying to tell you. If you fail to do this, your plan will be at risk of leading to failure and optimization, more than a benefit, could make things worst.

So let’s say you’ve come up with a sound and robust plan …

• How do you know if your plan is fully optimized?
• If your plan has reached an optimized state, how long can it be sustained?
• If not, should we think of optimization as a never-ending game?
• If so, could you ever be over-optimized?

Let’s start with some basic definitions

Optimization: the act, process, or methodology of making something – a design, system, or decision – as fully perfect, functional, or effective as possible given an agreed-upon objective function.

Objective Function: is a means to maximize (or minimize) something. This something is a numeric value. In the real world, it could be the cost of a product, profit, income, expenses, net worth, cash flow or any other key performance indicator (KPI) of interest. With the objective function, you are trying to arrive at a target for any of these variables given inputs (predictors) that influence their behavior.

Key Performance Indicator (KPI): is a measurable value that demonstrates how effectively an individual is achieving key business or personal objectives. Individuals and companies use KPIs to evaluate their success at reaching targets. In general, the personal finance community thinks of net worth as the most important KPI on the journey to Financial Independence.

Gap Analysis: it’s a process that involves the comparison of actual performance with desired performance. Implementation of this process usually reveals areas of improvement and facilitates building a roadmap to close the gap between business requirements and current capabilities

Now back to the questions!

How do you know if your plan is fully optimized?

Totally subjective and will vary from one individual to the other. If optimization is the process of making something perfect, then by definition, nobody can ever be fully optimized. If you think you are, then I’m sorry … you’re not. But wait … not all is lost, there are quite a few things you can do to optimize your finances. I invite you to think of these steps as a series of sprints.

This comes from agile project management which is centered around the idea of having incremental and tangible deliverables every 2 weeks and gathering feedback to make your product or your plan as relevant and appropriate to the product owner. In this case, the product owner is YOU.

So on your mark, get set, go …

• Sprint #1
  • Start tracking your income and expenses.
  • Rank your debt from highest interest rate to the lowest.
  • Calculate how much you pay in fees.
  • Understand your employer’s benefits: 401(k), HSA, stock options, etc.
  • Set goals and start reading books about personal finance. Consider I will Teach You To Be Rich and The Simple Path To Wealth.
• Sprint #2
  • Negotiate your monthly bills.
  • Consider refinancing and/or consolidating debt if it makes sense mathematically.
  • When it comes to consumer debt, pay credit cards starting with the one that has the highest interest rate.
  • If options in your company’s sponsored 401(k) are reasonable (index funds with low expense ratios) and you get a match, consider contributing up to that number.
  • Get rid of all unnecessary bank fees, especially those associated with account maintenance and/or late payments for services.
• Sprint #3
  • Start an emergency fund using an online savings account (I use Ally bank) and park 3-6 months of expenses.
  • Put things on autopilot (but don’t just set it and forget it) and take advantage of automation.
  • Consider contributing to your company’s sponsored HSA if you get a match and options are reasonable.
• Sprint #4
  • If you’ve created a nice gap between your income and expenses and still have money left then maximize your annual contribution to your 401(k) and HSA.
  • If you still have money left then open an IRA and maximize on an annual basis.
  • If you still have money left then open a brokerage account.
  • Above all pay yourself first.

The process above is definitely not a perfect one but I firmly believe perfection is the enemy of done. Most of these steps have room for optimization based on what your objective function is and the results you’re trying to achieve.

• Lower expenses: housing, child care, groceries, transportation, utilities, subscriptions, and services.
• Increase income: base salary, bonus, asking for a raise, switching jobs, adding high-paying skillsets or certifications to your resume, investing, creating sources of passive income, gig economy, starting your own business.

Consider performing a gap analysis of your expenses and income. This will help you identify and document the key factors worth including in your action plan. Please consider an agile approach and make sure your expectations are always reasonable.

There’s a ton of content out there on ways you could optimize every single parameter that influences both income and expenses and hence net worth. My intent is not to get into the weeds of every one of them but to highlight those you could focus on to get the ball rolling.

If you want to know my opinion, I don’t think I’ll ever be fully optimized. This creates a lot of anxiety because I’m constantly thinking about ways to lower our expenses and increase income. I know my wife is on board with our long term plan but I know I drive her nuts from time to time. Below is a summary of what I consider a semi-optimal strategy for the time being.

Objective Function: Lower Expenses

• Housing: own our primary home and carry a 30Y mortgage at 3.125% interest rate. I make bi-weekly payments which yield 13 payments in a year. This is cutting down the duration of the loan and a little bit of interest. I don’t intend to increase my payments given the rate I was able to lock.
• Childcare: Our oldest is about to start kindergarten but our youngest will start soon. This line item will continue to be a big hit every month. We love the school so not a lot of options at this point. The good thing is that my employer gives me $6,000/year which helps offset some of our expenses.
• Transportation: we own two used vehicles. One is fully paid and the other carries a loan with a 5Y 3.25% interest rate. Have done the math and not worth refinancing. I should be done at the end of the year.
• Groceries: buy store brands, bulk when it makes sense at Costco, use rewards app like ibotta, Dosh, Drop and use the American Express Blue Cash Preferred which gives 6% cash back on groceries.
• Utilities: signed up for grid-demand cost package for electricity. Water and gas costs are ok but I always check.
• Subscriptions: gym for the family at $75/mo, cell phone at $150/mo for wife and mine with my employer reimbursing $75/mo. Cut cable and only carry Netflix and Amazon Prime.

Objective Function: Maximize Income

• Salary: I document my work in the context of goals and deliverables. This is followed by a meeting I set with my supervisor 4 months ahead of salary/promotion discussions so that I can communicate my achievements and build a case to support my expectations. A couple of years ago I put together a market analysis of salaries for my job title. When I shared with my manager he was shocked but receptive and very much appreciative for the due diligence. I’m not sure if this was effective or not; however, when raises were announced, the number I got was on the high side in the range of expectations.
• Investing: my strategy comes down to paying myself first using all investment vehicles available to my disposal. That includes 401(k), HSA, IRAs, 529s and brokerage accounts. I’m fortunate in that I’ve been able to maximize annual contributions on all tax-deferred accounts for several years while still directing money to my brokerage accounts.
• Interest: I’m a big fan of online savings accounts like Ally, City and Capital 360. Not only do they offer signup bonuses in the form of “free” cash (conditions apply) but the interest rates are competitive at ~2.20+% APR. This is where I keep my emergency fund and capital I could deploy for opportunities such as the one below.
• Real estate: I have rental properties that generate positive cash flow. I’m pretty happy with my results but definitely will be looking at adding more units to my portfolio. My goal is to use the income from rental properties to cover my monthly expenses.
• Dividends: I could consider dividend as income but since I re-invest them automatically I’m not sure it counts.

If your plan has reached an optimized state, how long can it be sustained?

Not sure I know the answer to this one but I find myself challenging the status quo almost every single day. I seem to be following what most in the personal finance community would consider a “good plan”; however, I want my plan not just to be good, I want it to be great.

Here are some guidelines I’ve found in the personal finance community. I don’t think of them as strict protocols everyone should follow but more so as simple elements of a Financial Independence blueprint.

I don’t do this at all

I do this almost religioulsy but It feels I should be doing more.

I look at the stock market every single day. I’m not an active trader but I check my Robinhood account every day to see the handful of stocks I have and evaluate pulling the trigger on selling or buying any of the ones I keep on my watchlist. This is my fun money account.

I look at my net worth every day.

First, I don’t think an optimized state can truly be reached but if so, I don’t think it can be sustained for too long. Maybe we ought to think of words like progression and/or evolution more so than optimization. I think this might be a better fit for personal finance because conditions will always change and that may require adjustments to get back to an optimum state.

Is optimization a never-ending game?

I honestly think it is but it shouldn’t drive you to insane anxiety. Automation can certainly do a lot of the heavy lifting but it ultimately comes down to your objective function and where you’re at on the journey for achieving for Financial Independence.

For example, we never had any student loan debt or crazy consumer debt. The only debt we carry is in the form of a mortgage of our primary home and a car loan. I’m also fortunate in that I have a good job that pays very well and in which I could see myself growing professionally for years to come.

I would consider us to be in the accumulation phase so optimization would look very different If we had a ton of debt, had lower income or if we were transitioning into the distribution phase.

Whatever you do, I suggest thinking of optimization in the context of the law of diminishing returns. This is at the forefront of most things I do (at least from an awareness standpoint); however, I’m not quite there yet.

Could you ever be over-optimized?

Perhaps. I guess it comes down to the value you’re getting for the extra effort you’re putting in. Furthermore, are you enjoying the journey or are you and others around you feeling miserable and hopeless?

I think JD Roth from getrichslowly.com did a great job sharing his thoughts about this same topic. He doesn’t get into the weeds about optimization or over-optimization; however, he emphasizes the value proposition of focusing on the needle movers first (same concept as the 80/20 rule) and not wasting your time tweaking the things that have minimal influence on the bottom line. He calls this the optimization trap.

This is kind of an opposing view to the latte factor by David Bach but I think both have defendable and valid points of views. Bach states that you should not only pay attention to your big expenses but also consider the small ones because with time they do add up.

If you consider these two strategies, one can immediately notice the need for a clear understanding of your current state on the path to Financial Independence. As such, their message could become a powerful combination that’s complimentary instead of being mutually exclusive.

Having said that, I can’t avoid thinking about the emotional and psychological aspects of optimization or better yet the progression of your financial plan.

As I said earlier, I’m constantly asking myself the following questions:

• What am I missing?
• What else could I be doing?
• How could I lower our expenses even more?
• How do we generate more income?
• How do we get more deals on rental properties?
• Should I increase my exposure to individual stocks?
• Should I invest more than I do today?
• Starting a business sounds appealing but what do I do?
• Love travel hacking so which credit card should we open next?

The answers to these questions are still in the works.

Final Thoughts

I’m not sure if you’d call this an obsession or not but the truth of the matter is that I’m struggling to turn the volume down. It seems like the more quiet things are the more noise I’m eager to welcome.

Some of the effects are pretty obvious but If I could summarize them I’d say:

1. Anxiety,
2. Frustration,
3. Disappointment,
4. Stress.

Self-awareness is a good first step; however, I’m still not quite sure if we’re talking about an addiction to over-optimization or not. I care about my family and our future and that’s the engine that pushes me to do better every single day.

I need to remind myself that is ok to be thinking about the future but it should not be at the expense of being absent or feeling miserable 24/7.

In the end, my quest for achieving Financial Independence shouldn’t be entirely focused on reaching that destination but more importantly about enjoying the journey to get there.

So what do you think, time for an intervention?

Until next time … JJ