Instead of panicking about how you’ll make ends meet or cover an unexpected bill, solid financial health gives you the power to:
Cover an unexpected bill using your emergency fundLeave an abusive relationship without fear of having no moneyChase opportunities that align with your passions versus what will pay the billsInvest in a housecleaner or meal-prep service to free up more timeQuit a job you don’t like and pull from savings until you can find a new one
However, if you’re struggling with low-paying jobs or making ends meet, the traditional definition of “good” financial health may not be possible. For example, more than 1 out of 10 people live in poverty, and more than 10 states have a minimum wage below $8. In these situations, maintaining good financial health isn’t always about saving money or building net worth. It could mean keeping a consistent budget, finding sources of financial help, and avoiding expensive funding such as payday loans.
Example of Financial Health
The term “financial health” can be pretty vague. Here are some concrete examples of good financial health:
You can handle a major unexpected expense because you have money set aside for emergencies. You feel secure in your financial future. You feel like you can afford the things you want in life—even if you have to save up for them. The way you manage your money allows you to enjoy life. You don’t feel financial strain when you buy someone a gift for a wedding, birthday, or baby shower. You have money left at the end of the month. You control your finances, rather than having your finances control you.
On the flip side, your financial health could be in bad shape if:
You feel saddled with high-interest debt. You spend all your paycheck as soon as you get it. You lose sleep at night thinking about your financial situation. Money stresses you out. You’re frequently worried about being able to make ends meet.
How To Measure Your Financial Health
There are a few key indicators you can use to measure your financial health.
Savings Rate
Your savings rate is a good indicator of your financial health because it tells you how much of your income you save each month. A 10% savings rate means you save 10% of your paychecks. In general, the higher your savings rate, the quicker you can reach your financial goals. For example, if you want to buy a car to improve your chances of getting a better-paying job, saving 10% a month can help you store up enough money to cover the cost of owning a car.
Debt-to-Income Ratio
Your debt-to-income ratio measures how much of your monthly income goes toward paying off debts. Generally speaking, a good debt-to-income ratio is anything below 36%. Any higher than this, and you could struggle to make your payments or get approved for new loans. If you make $4,000 a month and $1,000 of your paycheck goes toward debt, then your debt-to-income ratio is 25%.
Credit Score
A high credit score means you’re managing your debt well, and you’re more likely to get approved for lower interest rates in the future. If your credit score is low, it means you’ll end up paying more in interest over the long run.
Net Worth
Your net worth is the value of your assets (car, house, savings account, stock, etc.) minus the amount of money you owe. Positive net worth may be a good sign of financial health—it means your assets are more than your debt. For example, if you have $250,000 in assets and $100,000 in debt, then your net worth is $150,000. Negative net worth means you owe more money than what you have in assets—owing $100,000 while having assets worth $25,000 means your net worth is -$75,000.
Set financial goals so you know what you want to achieveSpend less than you earnCreate a budget to track your spendingAvoid unnecessary debtImprove your credit scoreTrack your net worthWork on changing your financial mindset
Have an emergency fundHave little to no high-interest debtCan pay your bills and still have money left over to fund your goalsHave a budget and you’re good at sticking to itRarely stress about moneyFeel confident and in control of your finances
title: “What Is Financial Health " ShowToc: true date: “2022-12-03” author: “Laura Jordan”
With that in mind, financial health can be defined as the state of well-being of a person, business, or institution’s finances. It’s important to understand that, as with your regular health, your financial health is not merely based on the absence of things like debt. It takes many factors into consideration. For instance, much like the way physicians measure physical health with metrics like blood pressure or body mass index (BMI), you can measure your financial health with metrics like your credit score, debt-to-income (DTI) ratio, or net worth.
How Financial Health Works
Financial expert and author Emily Guy Birken told The Balance by phone that every individual must look at their own unique financial picture. “Financial health has a lot of parallels with physical health, in that there is no one single metric that determines health,” she said. “You may not be living paycheck to paycheck, but what are your debts? Do you have insurance? How big is your emergency fund? It can feel like a moving target because there’s not one metric to hit.” “If you work on one, it will surely benefit your overall health,” Guy Birkin said. “If you quit smoking, you may gain weight, but it improves your overall health. If you pay off high-interest debt, your cash flow might decrease for a while, but your overall financial health improves.” Guy Birken said that consumers should think about the metrics used to determine financial health as vital signs. Income is a vital sign of financial health. It’s not necessary to have a high income, but expenses should be less than money earned. Debt can also be a vital sign. A high DTI ratio may be a warning sign that your financial health isn’t that great, while a low ratio may be a sign of good financial health. Getting to know the metrics used to measure good financial health is one way to start improving and maintaining a state of financial well-being.
What Are the Metrics Used To Measure Financial Health?
The mere ownership of assets is just one metric that can be used to measure financial health. Assets are anything that contributes positively to net worth. Assets can include:
Money in your emergency savings accountInvestments like shares of stock and mutual fundsRetirement accountsInsurance coverage
Guy Birken said that adequate insurance is one metric that works better as an indicator of ill financial health. “Driving without car insurance is not a choice made by someone in good financial health,” she said. “If you do not have health insurance, you are in a precarious financial state. And people don’t realize how necessary disability and life insurance are. If you get COVID-19 or pneumonia and you need three months to a year to recover and you don’t have disability insurance, then you’re out of luck.” There are also metrics that include liabilities in calculating financial well-being. For example, your DTI ratio, which measures how much debt you have in contrast to your income, may be used to calculate your credit score. It can also be looked at on its own, such as when you’re applying for a home loan. Credit scores can also be used as a metric on their own, such as when you’re applying for a credit card or personal loan. Net worth is another metric that may come into play. For example, if you’re in good financial health, you most likely have a higher credit score. Or maybe your DTI ratio is at or below 36%. Your net worth might also be positive, which means the total of your assets equals more than the total value of your liabilities.
How You Can Improve Your Financial Health
The best first step in improving your financial health is to track your spending by creating a budget. By knowing exactly how much money you spend, you can more accurately plan to increase your income or cut back on unnecessary expenses if needed. Once a budget is created, you can set money aside for building an emergency fund and reducing or paying off debt. As you pay down debt, your DTI ratio will go down, while your credit score will go up—all good things for your financial health. With less debt, you may have more disposable income and may be able to afford more insurance. Once all of those metrics start to improve, add up the value of your assets (like your savings or home equity) and subtract the value of your liabilities from that number (like student loans and mortgage debt). The result is your net worth. You can take steps to improve your net worth, and in doing so, the other metrics will surely improve. Guy Birken said consumers should also remember that the outcome of any metric can be beyond their control. “There is a sense that if you do everything right, your financial health will be perfect,” she said. “That’s simply not the case. Catastrophes can certainly happen to healthy people. There are going to be things that are out of your control, which is why it is important to do what you can.”
