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In today's ever-changing financial landscape, staying on top of your financial health is more crucial than ever. Whether you're navigating through life's major milestones or simply aiming to secure a stable financial future, conducting a thorough financial checkup is a vital step.
This guide dives into the essentials of assessing your financial health, from understanding the impact of life changes on your finances to setting and achieving your financial goals.
We'll explore practical strategies for managing debt, optimizing your savings, ensuring adequate insurance coverage, and more, to provide you with a comprehensive roadmap for financial wellness.
Join us as we break down the process into manageable steps, empowering you to take control of your finances and pave the way for a secure and prosperous future.
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Introduction
Financial health is a way of looking at your finances to see if you are healthy or at risk. Most people take care of their physical health. Fewer work on their mental health. Most people do not think about their financial health until it it too late.
In this article, we will look at what goes into financial health and ways to improve yours.
Financial Health Indicators
There are several financial health calculators online. You can use one of those or start with a basic overview by answering the following questions.
Are you prepared for unexpected events?
This question asks how you will handle those unexpected events like a medical emergency, job loss, car problems, household appliance breakdowns, and other large ticket events that cause people to go into debt.
If you do not have an emergency savings and depend on credit cards to get through an emergency, your financial health is not very strong.
What is your net worth positive or negative?
Net worth looks at how much you are worth monetarily. To figure out your net worth, add up everything you own (using a realistic value for your assets). Next, add up everything you owe - mortgage, debts, etc. Then subtract what you owe from what you own. This will give you your net worth.
If it is positive, you own more than you owe. If it is negative, you owe more than you own. A positive net worth means your financial health is good. A negative one means your financial health is sick.
Do you have the things you need in life?
Needs are something you must have to survive. This includes food, shelter, utilities, and clothing. this is very different from wants - the things that make life more pleasant.
If you can not afford your needs, you are not in good financial health.
DO You have the Things you want
Wants are the fun things in life. These are things you do not need to survive. Do you have some of the things you want - most of us will never have everything we want - but the goal is to have the opportunity to have them.
If you are unsure what the difference is between a need and a want, ask yourself if you can wait 24 hours. If you can it is a want.
Be aware that needs can become wants. You may need a car, but do you need a high-dollar, expensive-to-maintain model? You need a cell phone, but do you really need the newest version? You can apply this question to practically everything you need and want.
How Much Do you spend on high-interest debt?
High-interest debt includes items like credit cards. If more than 50% of your debt is high-income, you are not financially healthy.
Do You Have Retirement Savings?
Even if you are young, start putting money away for retirement as soon as possible. Social Security may not be there for you, so don't count on it. Take advantage of any retirement accounts offered through your employer and set up an IRA or similar option. At the barest minimum, put $1000 a year ($20 a week) into a retirement account. Making retirement funds is very important to your future.
Do you have insurance coverage?
Insurance is important. If you have a vehicle, you need insurance to protect you. If you have dependents, you need life insurance. And even if you are healthy, you need at least catastrophic health insurance.
Insurance is a racket, but if you do not have insurance, you leave yourself open to financial ruin.
Assessing Your Financial Health Score
By now you should have either a feeling of relief that you are not doing too badly or that sinking feeling that suggests something is wrong.
Financially Vulnerable
The worst level is financially vulnerable. If you are having trouble keeping up with your bills, your savings are non-existent, and you are one surprise bill or emergency event away from disaster, you need to pay some very close attention to your finances.
One problem with being financially vulnerable, you do not have the resources to access financial assistance like low-interest loans or credit.
If you are in this category, spend time learning the basics of personal finance. There are some great books available or talk with a credit counseling agency to help you learn money management.
Financially Coping
If you can meet your bills but aren't putting away money into savings, you fall into this category. You might be three or four emergency or surprise bills away from becoming vulnerable.
You have better access to resources like low-interest loans or credit.
A credit counseling agency, basic finance class, or a book will help you to understand basic finances.
On top of that, learn about managing debt, improving your credit score, set up savings to help you with emergencies, retirement, home purchase, etc.
Financially Healthy
If you are one of the lucky few who fall into this category, you have excellent credit scores, under-control debt, and are on track for emergency savings and retirement.
You have excellent access to resources like low-interest loans or credit.
If you are in this category, maintain your financial health and continue with your savings plans. Just because you fall into this category, you can not start spending. Otherwise, you will slide down to coping and vulnerability.
Now What?
Now that you know financial health let's see how you can move into a healthier category. Improving your financial health can improve your physical and mental health!
Understanding Your Income
Gross vs. Net Income
If you look at your paystub, you will see the terms gross, and net next to income, and the net is lower. What is the difference?
Gross is the total amount you have earned. Gross also means big, total, or whole. Net is the amount left over after payroll taxes and deductions are removed. Think of the net as what is left after you pull a net out of the water - the fish are your take-home pay.
Payroll taxes include things like social security, unemployment, and income taxes. Deductions are monies that were taken out to go into retirement funds, etc.
Importance of Stable Income
Having a stable income is important to managing money. If you work on commissions or tips, try to budget off a reasonable amount, usually the average you make over several months.
Extra money is put into savings or retirement savings.
Setting Financial Goals Based on Income
Set your financial goals based on how much you make and your financial health. If your financial health is good, set aside as much as you can into savings.
If you are vulnerable, set your goals on moving up to a less precarious existence. If you haven't already, you may need to cut expenses to the bone for a few months or years. If you already have done that, you may need to increase your income somehow to build up a financial cushion.
Managing Your Expenses
The best way to manage your expenses is to have a budget. Budgets come in dozens of different styles. You can budget down to the penny to merely use the budget to cut out expenses. It's about understanding yourself and your spending habits.
Tracking Your Spending
To understand where you are spending money, you need to know where you spend money. That seems self-obvious, but you may not realize how much you spend. It is easy enough to whip out a few dollars and buy a drink and then forget what you spent.
Spend at least two months, preferably three or four, tracking every penny you spend. Write it down!
Sort out the expenses into spending categories. Some trends will immediately leap out at you.
Identifying Fixed vs. Variable Expenses
Expenses come in two varieties, fixed and variable. Understanding these can help you to manage your money.
A fixed expense is one that never changes. This includes your mortgage/rent payment, auto loan debt, streaming services, and other similar debt.
Variable expenses change each month. These include utility bills, grocery bills, and items that fluctuate.
Fixed expenses are simple to budget for. Variable ones are much harder. Use either an average of several months, or adjust your budget seasonally, knowing that, for instance, utility expenses will vary during winter/summer.
Creating a Budget to Manage Expenses
Now you are ready to create a budget. Add together all your income. Add together all your spending. Subtract the spending from the income. If it is positive - good job. Now set up savings. If it is negative, you have some examining to do.
Whether it is positive or negative, go through each category of expenses. Can you cut down on something? Do you need multiple streaming services? Did you need those expensive shoes? Can you trim your grocery bill? Do you need to move to a cheaper home or add a roommate?
Building Your Savings
Your goal in budgeting and examining your spending habits is to free up money. Once you do, what do you do with that money?
You should have two goals: paying down debt and saving money.
Importance of Having an Emergency Fund
Having money set aside is extremely important. Unexpected bills happen to all of us. If you have an emergency savings account, you hopefully will not need to tap into your credit cards or take out a car title loan.
Start small but put money aside regularly.
Setting Savings Goals
Most banks will allow you to have several accounts attached to your checking account. Start by setting up three. One is for emergencies, one for retirement, and one for general or debt savings. Eventually, you can then add annual expenses, and long term purchases.
Once your emergency fund is set up, focus on building up $1,000. It will take a while and you will probably need to keep rebuilding the fund. Put any unexpected income into the emergency fund until you reach that amount. If you spend part of it, build it back up. If you can, eventually, you need to build up to a total of three months' living expenses in your emergency account.
Next, set up your retirement savings. Put $20 a month into it. When it reaches $1,000 or once a year, transfer it to a retirement investment account.
Once you have the first two funded, start on your debt savings - if you have debts - or general savings. Once you reach $1,000, pay off debt and start saving again. If you have no debt, it is time for the next two accounts.
Annual expenses are those expenses that are paid once or twice a year. This depends on your circumstances. Add up all your annual expenses, divide by twelve, and put that amount into this account each month.
Long-term purchases are those that are expensive or, you know, are coming. Household appliances, car tires, vacations, etc, are long-term purchases. Your priorities are the first three, but if you can, put aside a month into long-term purchases.
Strategies for Building Savings
There are many strategies for building your savings.
- Pay yourself first - ask your HR to direct deposit a certain amount of money each month into your savings. Then move it into the proper savings account.
- Sell whatever you do not need. Most of us have a lot of stuff. Sell what you can and use that money to fund your savings accounts. Consignment stores are not only great places to save money but to make it as well.
- Cut down on expenses to free up cash.
- Save coins. When your coin jar is full, deposit that into savings.
- Put at least 50% of unexpected income into savings.
Managing Debt
Pretty much every adult in the US has debt. The current estimate is that the average American household has about $165,000 in debt. Let's talk about debt for a bit and how to manage it.
Types of Debt
Debt can be divided into three categories. These are good debt, bad debt, and grey debt. Here's the difference.
Good debt is debt that is creating something or increasing your net worth over time. A mortgage, business debt, or a college education is considered good debt.
Bad debt is debt that does not contribute to net worth or future income generation. This can be credit card debt, excessive purchases of "wants," or other high-interest loans.
Gray debt is somewhere in between. For instance, you need a car to get to work - that is sort of good debt. It becomes bad debt when you spend too much or buy more car than you need. Education is another gray debt. Education is super important - whether college or trade school. But racking up student loan debt for name recognition or because your favorite team is there is bad debt.
The Negative Impact of Debt on Financial Health Score
Good, bad, or gray debt has a way of sucking up spare money. All of them can drive you from good financial health to bad health very quickly.
Bad debt usually has either high-interest rates or compounding interest, or both. Interest is what you pay for borrowing money - the riskier the loan or, the worse your credit score, the high the interest rate.
Compounding interest is where you end up paying interest on interest. It becomes a trap that is hard to get out of. Here is an example: you have a $500 credit card balance. Your interest rate is 20%. You are roughly charged $100 in interest. Now you owe $600. You make a minimum payment of $50. You owe $550. The next month, you have an interest charge of $110 and owe $660. And so forth. This example is not exact, but it is close enough for illustration.
Strategies for Paying Off Debt
There are five main strategies, beyond what you are doing right now, to pay off debt. We will discuss three of them because the last two, debt settlement and bankruptcy, are nuclear options and should be used as the last resort.
Snowball Method
In the snowball method, you concentrate on paying off the smallest debts first and then rolling that payment onto the next smallest bill until everything is paid.
This assumes you are not adding to your debt, you can make minimum payments on all the rest, and you have some extra cash to pay down the debt.
Avalanche Method
In the avalanche method, you concentrate on the highest interest debt, pay that off and then focus on the next highest debt.
This assumes you are not adding to your debt, you can make minimum payments on all the rest, and you have some extra cash to pay down the debt.
Debt Consolidation
In debt consolidation, you take out a lower interest loan to pay off high interest debt. You then focus on paying down that loan (as well as any debt that could not be consolidated).
This assumes that you can get a loan with a low interest rate.
The Comparison
There is not much difference between the snowball and avalanche methods in terms of saving interest costs or time to pay off. The biggest difference is that you see progress more quickly in the snowball as each little debt goes to zero more quickly than the high interest debts.
Debt consolidation can save a lot of interest payments, if you can get a low interest loan.
Building Your Investment Portfolio
Investing is not just for rich people. Investing is also not day trading or playing the stock market. Investing is a long term strategy to build wealth.
Types of Investments
There are a number of investments that you can buy into to add to your portfolio. This blog will go over the basics and terminology.
Savings accounts
Savings accounts are a good starting place, but are not the place for a lot of money. You make a tiny bit of interest each month. It is a good place to hold money before moving it to a better investment type.
CDs
A CD or certificate of deposit puts your money away for a certain amount of time, usually six months to five years. At the end of that time you get more interest than you would with a savings account. The one drawback is that you cannot touch the money in the CD without losing part of all of the interest.
Money Market accounts
For the investor, a money market account is a savings account that makes more interest. You generally need to keep a minimum balance in your money market in order to get the best interest rates.
Stocks
A stock is a way to buy part of a company. The company sells shares in order to raise capital for projects. You buy the stocks which then should pay a dividend on each stock you own. The dividend can then automatically be used to buy more stock in the company, or be paid to the investor.
Bonds
Bonds are ways for cities and other governments to raise money for projects. Basically, you buy a bond, the government uses the money to build something, and then at the end of a certain amount of time pays you back the face value of the bond (what you paid for it) plus interest.
Importance of Diversification
You know the old saying, "Don't put all your eggs in one basket"? The same goes for investments. You can invest in a wide number of vehicles like stocks, bonds and money markets.
Young people may want more aggressive or risky stocks. Older investors may prefer safer stocks. You may want a mix of safe and risky.
All this depends on your risk tolerance!
Building an Investment Plan
The best way to invest is to find a good, trustworthy investment house. Look for a registered investment advisor (RIA) who can advise you and manage your portfolio. An RIA is legally required to have your best interests at heart and practice good risk management.
Your best plan is to start with a retirement account and build from there.
Can you do it yourself? Yes. But it is a lot of work and a lot of financial risk.
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