Effective Financial Assessment: Measure and Respond!

Net worth. Net worth, Net worth. Financial independence enthusiasts obsess over this. Bloggers push Personal Capital and many have a net worth target in mind. It’s true that net worth is important. But, if you’re only paying attention to net worth you aren’t conducting a full financial assessment.

Good educators know that effective assessments applied for the appropriate reason is key to improving student learning. Unfortunately, many recent education reforms have emphasized the least effective types of assessment. Good schools have implemented better balanced assessment systems that use assessments for the right reasons. 

Assessment of progress is also critical in pursuing financial independence. Unfortunately, it’s easy to emphasize the wrong measures here too. Trying to improve your financial progress by only paying attention to net worth is like trying to improve reading by only measuring your “reading level.”

Today, we’ll explore how effective academic assessment can be applied to personal finance. Then, we’ll use that understanding to help you assess your progress and adjust more effectively.

A Balanced Assessment System

A balanced academic assessment system includes three types of assessment:

• Formative
• Interim
• Summative

The Three Tiers

Formative Assessment

Formative assessments are frequent (often daily or by lesson) quick assessments that tell an educator if a student is learning a skill. They allow for quick corrections in misunderstanding, changes in instructional strategy, or progression to more advanced concepts.

This is the most effective type of assessment to improve student learning because of the frequency. The entire purpose of formative assessment is quick feedback that allows for adjustment. Because of this, formative assessment is often referred to as assessment for learning.

Formative assessment asks “Has the student acquired this discrete skill/concept?” In a good academic learning structure, that skill is a building block for the overall course target. By improving these subskills you improve progress overall.

Due to the frequency and individualized nature of formative assessments, they don’t typically make for good reporting tools. This is why school ratings, and press coverage, is generally based on summative assessment. It’s easy, though not that useful.

Interim Assessment

Interim assessments happen less frequently, but still several times during a course or academic year. The purpose of interim assessments is to measure student progress toward learning the overall content and to evaluate whether they are on track to meet the learning goals by end of course. 

Basically, an interim assessment asks “Is the student making adequate progress to meet the target?” These mid-point checks allow adjustments in instructional strategy and identification of learning gaps that may not have been noticed earlier.

Summative Assessment

Summative assessments measure whether a student has met the overall target for the course / year. Think of an end-of-year test to determine whether a student is “on grade level” or has “passed calculus.” They are a measure of the outcome of learning for the course/year.

Typical measures of school and student performance today emphasize the summative assessment. A summative assessment is often compared to an autopsy: It measures the outcome of what has already happened.

In an assessment system that uses or emphasizes the summative assessment, you test a student once a year and declare that student (or the school) a success or failure.

Summative assessments are most frequently used as reporting tools.

Examples

Ineffective

It is ineffective to only use summative assessments when trying to improve learning. You can’t teach a kid to read by measuring whether they can read. (Just like you can’t make progress to financial independence only by measuring whether you are already FI…)

A school without a balanced assessment system typically focuses on the summative. Let’s say a third grade student takes a state reading test at the end of the year and does not meet the standard.

That student then goes into fourth grade and goes through another year of instruction. Without formative or interim assessments no one, including the student, really has an idea of whether he is on track. 

At the end of fourth-grade, the student takes the state reading test again. Do you think he passed? You don’t have enough information to predict? Exactly.

Repeat. Each time a student takes a summative and is told they “passed” or “failed” without any other information the system has failed them. 

You are essentially trying to teach a student to read by measuring whether he can read once a year. That makes no sense.

Effective

With a balanced assessment system, everything is built to frequently measure and support progress. If the student above were in a school with a balanced assessment system his experience would be different.

Throughout third-grade, his classroom teacher would be assessing progress on the discrete skills required to be reading at grade-level by the end of the year. As one example, the standard may require a student to “Talk about a text using specific examples of the text.” The student would be assessed for his ability to do exactly that. If he can do it – great. If not, instruction on that skill would continue.

Three times a year, he would be given an interim assessment to determine overall progress. At the first interim, he isn’t on track. The school applies extra reading support.

When it’s time for the summative, everyone involved has a pretty good idea of whether he is on track to meet the third-grade standard. The summative result won’t be a total surprise. It doesn’t guarantee that he will pass, but it makes it much more likely that he will meet the standard now or in the future.

The formative assessments tell both the teacher and student which skills he has mastered and which he is still working on. The interim assessments have provided information on where he is in the overall learning sequence. The summative is a final check for the year.

If he isn’t on track at the end of third-grade, all of that information will support the student in fourth grade. It is much more likely that he will enter high school prepared to graduate on time.

How Does This Apply to Financial Independence?

If you are measuring only net worth you aren’t assessing your financial independence progress as effectively as you could. Net worth is an outcome of your cumulative actions, not a skill. Measuring other indicators more frequently will increase both your ability to progress and the likelihood that you’ll eventually achieve the outcome you desire.

Here is a suggestion for a balanced financial assessment system:

Summative Assessment – Net Worth

Measure your net worth! The point is not to ignore a critical indicator, but to use it appropriately.

I’d suggest measuring it annually, or quarterly at most. Understand that this is a measure of the outcome of your work, not the work itself.

Financial independence is the point at which your passive income exceeds your spending. So your net worth and its ability to produce the income you need is the ultimate measure of financial independence.

You should definitely measure your net worth as your summative number. 

I personally measure net worth quarterly by spreadsheet. If you want a quick tool that does it for you after a little bit of set-up, then Personal Capital is very useful. (affiliate link)

Interim Assessment – Savings Rate

Savings rate makes a great interim measure of your progress to financial independence.

The percentage of your income you are saving tells you how fast you will reach FI. It’s also directly related to growth in your net worth. In short, it’s a perfect measure of how your actions impact the summative measure. An interim assessment!

If you are able to measure your savings rate on a monthly basis you’ll have a good idea of how your net worth is growing when you eventually measure it. 

This post does a great job of explaining how your savings rate impacts the growth of your net worth and progress to FI.

Looking at your savings rate monthly also allows you to course correct as needed. If you’ve fallen below your goals, or had a surprise expenditure, you can adjust your actions in the following months to get back on track.

In short, it’s a medium-term assessment that links to your long term target. A perfect interim assessment!

Formative Assessments – Your Short Term Goals

Formative assessments are frequent and individualized. It’s impossible for me to say what is the best current formative assessment for you and your progress. It is easy for me to say the best financial assessment system will include frequent formative checks.

Yet, paying attention to your progress on short term goals/concepts is how you adjust your savings rate and eventually reach your long-term target.

Financial formative assessments can be a yes/no on your ability to achieve a short-term target, a measure of your understanding of a concept, skill-based, or a specific money metric.

Learning and growth happens when we break it into small blocks. As we stack those blocks on top of each other we achieve success. Each time you achieve a short-term financial goal or acquire new understanding, you improve your ability to save and grow your net worth.

Examples of short term actions /skills that you can assess:

Tracking your expenses 

Do you know how much you spend each month and on what? If not, you can start here. Build a system for yourself to track your expenses.

Set and Meet a Spending Budget 

The ability to even set a budget is a building block skill for many people. 

After you set a budget, can you actually meet that budget? Trust me, we’ve had budgets before that did us little good because we never met them. Whoops!

Automate Your Investments

Are you “paying yourself first?” Set a goal to automate your investments, then break that into subgoals. Assess each. 

• Set a year-long target
• Open a brokerage account
• Select an investment
• Set-up payroll withdrawal or contribution from savings

Meal cost target 

Perhaps you’ve identified meal costs as an area of savings. You decide that you want to average $3/meal per person. A perfect formative assessment!

When you start out you are over $5/person. You try some strategies and push that down to $4. Adjust and assess – you’re now at $3.50. Eventually, you figure what works for your family and get down below your target amount. 

In this case, the meal savings allow you to increase your savings rate. Your net worth progress is then faster. A perfect link between formative – interim- and summative assessments.

Travel Hacking 

This is our current short-term goal. We are learning about travel cards and how to most effectively use them. Skills, concepts, and actions that we’ve worked through:

• Identify credit card miles bonuses (check)
• Understand the Chase 5/24 rule (check)
• Open new cards (check)
• Meet and track minimum spend (check)
• Understand how to book travel (check)
• Maximize value of points (in progress)

Implement a Balanced Assessment System to Effectively Assess Your Financial Progress

If you measure your financial progress according to the key tenents of a balanced assessment system, you will dramatically increase your chances of success!

Personal finance is personal and the best assessment systems recognize the needs of each learner. Your financial assessment system may look different, but the building blocks are:

1. Formative Assessment – Set and measure your progress on short-term goals and learning.
2. Interim Assessment – Measure your savings rate on a monthly or quarterly basis. Improve your knowledge and actions (measured with formative assessment) to improve or adjust this number as needed.
3. Summative Assessment – Measure your net worth to give you a snapshot of your progress toward financial independence. Remember that net worth tells you the result of your actions NOT which actions you should take.

I’d love to hear what numbers you track. What short-term (formative) goals and measures are you using?