Financial health is a term used to describe the state of one’s personal monetary affairs. There are many dimensions to financial health, including the amount of savings you have, how much you’re putting away for retirement, and how much of your income you are spending on fixed or non-discretionary expenses.
- The state and stability of an individual’s personal finances and financial affairs are called their financial health.
- Typical signs of strong financial health include a steady flow of income, rare changes in expenses, strong returns on investments, and a cash balance that is growing.
- To improve your financial health, you need to assess your current net worth, create a budget you can stick to, build an emergency fund, and pay down your debts.
Understanding Financial Health
Financial experts have devised rough guidelines for each indicator of financial health, but each person’s situation is different. For this reason, it is worthwhile to spend time developing your own financial plan to ensure that you are on track to reach your goals and that you’re not putting yourself at undue financial risk if the unexpected occurs.
Measure Your Financial Health
To get a better grasp of your financial health, it might help to ask yourself a few key questions—consider this a self-assessment of your financial health:
- How prepared are you for unexpected events? Do you have an emergency fund?
- What is your net worth? Is it positive or negative?
- Do you have the things you need in life? How about the things you want?
- What percent of your debt would you consider high interest, such as credit cards? Is it more than 50%?
- Are you actively saving for retirement? Do you feel you’re on track to meet your long-term goal?
- Do you have enough insurance coverage—whether it be health or life?
How Financial Health Is Determined
An individual’s financial health can be measured in a number of ways. A person’s savings and overall net worth represent the monetary resources at their disposal for current or future use. These can be affected by debt, such as credit cards, mortgages, and auto and student loans.1 Financial health is not a static figure. It changes based on an individual’s liquidity and assets, as well as the fluctuation of the price of goods and services.
For example, an individual’s salary might remain constant while the costs for gasoline, food, mortgages, and college tuition increase. Despite the good state of their initial financial health, the person may lose ground and lapse into decline if they do not keep pace with rising costs of goods.
Typical signs of strong financial health include a steady flow of income, rare changes in expenses, strong returns on investments that have been made, and a cash balance that is growing and is on track to continue to grow.2
Improving Your Financial Health
To improve your financial health you must first take a hard, realistic look at where you’re currently at. Calculate your net worth and figure out where you stand. This includes taking everything you own, such as retirement accounts, vehicles, and other assets and subtracting any and all debts.3
Then you need to create a budget. With your budget, it’s not enough just to plan for where you’ll be spending, but it’s also important to take a hard and close look at where you already spend. Are there areas where you could cut back? Recurring subscriptions that you don’t really need—such as cable? It’s fortuitous to understand what your “needs” are versus what your “wants” are.
Use spreadsheets or mobile apps to help set up a budget. Or, use the time-tested envelope method, which has you create an envelope for each budget item, such as groceries, and keeping the allocated cash in the respective envelope.4
One of the major keys to a budget, and maintaining your financial health, is to stick to your budget regardless of whether you start making more money or bringing in more income. Lifestyle creep, which includes spending more money as you make more money, is detrimental to your financial health.
Building an emergency fund can materially boost your financial health. The fund is meant to be money that is saved and readily available for emergencies, such as car repairs or job loss. The goal should be to have three to six months’ worth of living expenses in your energy fund.5
Pay down your debt. Use either the avalanche or snowball methods. The avalanche method suggests paying as much as possible toward the highest interest debt while paying the minimum on all others. The snowball, meanwhile, suggests taking the smallest debt balance first and then work your way up to the largest debt.6 There are pros and cons of each; pick the one that works the best for your debt load and your money-handling preferences.
Rules and Tips for Financial Health
When it comes to effective personal finance—keeping your financial health in tip-top shape isn’t always easy. We get caught up with living life. However, here are a few quick rules and tips that you can follow to either improve or keep you in good financial health.
- Automate your bill pay and savings—that is, set up automatic transfers to a savings account and auto-pay all your bills.
- Always look for free checking and free accounts.
- Shop around for insurance, cable or and other recurring expenses. This includes if you already have these items.
- Use a budgeting method, such as 50/30/20, which says you should be spending 50% on needs, 30% on wants and saving 20% of your income. This 20% could include debt reduction if you have high-interest debts.7
- Try to limit spending on housing (rent or mortgage) to not more than 40% of your income.8
- Invest early and often. That is, try to put 10-15% of your income directly into a retirement account.9
Business Financial Health
The financial health of businesses can be gauged by comparable factors to assess the viability of a company as a going concern. For instance, if a company has revenue coming in and cash in the bank, yet is spending its resources on new investments in production equipment, office space, new hires, and other business services, it may raise questions about the long-term financial health and survivability of the company.
If more money is spent that does not contribute to the overall stability and potential growth of the business, it can lead to a decline that makes it difficult to pay regular expenses such as utilities and employee salaries. This may force businesses to freeze or cut salaries in order to give the company the ability to continue operations.
- Investopedia originally published this article on October 12, 2022, and written by Julia Kagan.
- Image courtesy of iStock
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
- Federal Deposit Insurance Corporation. “Risk Management Manual of Examination Policies: Section 3-2 Loans,” Page 74.
- U.S. Securities and Exchange Commission. “Saving and Investing,” Pages 7-8.
- Charles Schwab. “Your Personal Net Worth.”
- Credit.org. “What Is the Envelope Budgeting Method?”
- Vanguard. “What’s the Right Emergency Fund Amount?”
- Wells Fargo. “Comparing the Snowball and the Avalanche Methods of Paying Down Debt.”
- Intuit. “50/30/20 Budgeting Rule: How to Use It [Instructions + Calculator].”
- Quicken. “How Much Should You Spend on Rent When Budgeting?”
- Fidelity. “How Much Should I Save for Retirement?”
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