What Is Financial Health?
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.
Key Takeaways
- 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 every individual’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 card debt, mortgages, and auto and student loans. Financial health is not static. It changes based on an individual’s liquidity and assets, as well as the fluctuation of the price of goods and services.
An individual’s salary might remain constant, for example, while the costs of gasoline, food, mortgages, and college tuition increase. Despite the solid state of their initial financial health, they may lose ground and lapse into decline if they do not keep pace with the rising cost 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.
Improving Your Financial Health
To improve your financial health you must first take a hard, realistic look at where you are currently. Calculate your net worth and figure out where you stand. This includes tallying up everything you own, such as retirement accounts, vehicles, and other assets, and subtracting any and all debts.
Budgeting
Next you need to create a budget. With your budget, it’s not enough just to plan for where you will be spending, but you must also take a 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? Distinguishing between your “needs” (mortgage, food, utilities, transportation) and your “wants” (gym memberships, dining out, your morning latte) can help you identify items in your budget that are more expendable.
Use spreadsheets or mobile apps to help set up a budget. Or, use the time-tested envelope method, which involves creating an envelope for each budget item, such as groceries, and keeping the allocated cash for it in the respective envelope. Then, when you do your food shopping, you take money out of that envelope.
One of the major keys to staying on budget and maintaining your financial health is to stick to your plan 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.
One budgeting strategy to consider is the 50/30/20 rule, popularized by Senator Elizabeth Warren (D, Mass.). It says that 50% of your salary should go towards needs, such as housing, food, transportation, and utilities; 30% should be used for “wants,” such as eating out, entertainment, and travel; and 20% should go towards savings.
Emergency Fund
Building an emergency fund can materially boost your financial health. The fund is meant to be money that you’ve saved and that is readily available for emergencies, such as car repairs or a job loss. The goal should be to have three to six months’ worth of living expenses in your emergency fund.
Debt
Debt can interfere with your financial health, so it’s important to pay down it down as quickly as you can. Use either the avalanche or the snowball method. 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 working your way up to the largest debt. There are pros and cons of each; pick the one that works the best for your debt load and your money-handling preferences.
Retirement
Many Americans are inadequately prepared for retirement. According to a 2024 AARP survey, 20% of those age 50+ had no retirement savings and more than half were worried that they didn’t have enough saved to see them through retirement. Having enough money to retire on takes planning. In general, the earlier you start to save for your post-work life, the better, so your money has time to grow. If you have a workplace retirement plan with an employer match, try to save at least as much as is needed to receive the match. Also consider opening an individual retirement account (IRA) to put away additional funds.
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 maintain or improve your financial health.
- Automate your bill payments 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, and other recurring expenses, even if you already have these items.
- Use a budgeting method, such as the 50/30/20 rule, which suggests you should be spending 50% of your income on needs, 30% on wants, and 20% on savings. This 20% could include debt reduction if you have high-interest debts.
- Try to limit spending on housing (rent or mortgage, not including utilities) to no more than 25% of your income.
- Invest early and often. Try to put at least 15% of your income directly into a retirement account.
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.
What Are the Components of Financial Health?
Financial health is a term for the state of your personal financial affairs. It includes the amount you have in assets (home, savings, retirement accounts, and more), your level of debt (student, credit card, and other types of debt), and the amount of income you spend on nondiscredtionary items, such as housing, food, and transportation.
How Much Should I Save for Retirement?
The amount you save for retirement depends upon numerous factors, including your salary, your life goals, and how much you will need in retirement. But given that many haven’t saved enough—a 2024 AARP survey found that one in five Americans ages 50+ had no retirement savings—it’s smart to start in your 20s and save at least 15% of your income annually throughout your working years.
Another way to think about it, and one that many experts recommend, is to save 10 times your pre-retirement salary and plan on living on 80% of your pre-retirement annual income.
What Are the Signs of Good Financial Health?
The signs of good financial health typically include earning a regular income and strong returns on your investments, and having infrequent changes in your expenses and a cash balance that is growing.
The Bottom Line
Good financial health means that you are successfully managing all the facets of your financial life. It takes work to stay on top of your finances as you go through life and meet your changing needs and goals, such college education for your kids, home ownership, and travel. It’s important to invest money in retirement funds for your future, including in a workplace plan like a 401(k) as well as individual retirement accounts. Meeting with a financial planner can help you strategize for all of your goals.
