How To Assess and Improve Your Financial Health

How To Assess Your Financial Health

Knowing your financial health helps you map out your retirement path, determine when you can buy a house and achieve other milestones. Once you know how to measure your financial health, you can monitor your progress over time.

During a comprehensive financial assessment, you should review the following information:

Key Financial Health Indicators

Net Worth

To determine your net worth, subtract your liabilities from the total value of your assets. For example, if you have $1 million in assets and $200,000 in liabilities, your net worth would be $800,000.

Cash Flow

Cash flow reveals whether you are retaining or losing money at the end of each month. A positive cash flow indicates good financial health, as it means you can cover your expenses. Conversely, negative cash flow often results from relying on debt to manage monthly expenses.

Debt-to-Income Ratio

This ratio measures your gross monthly income relative to your debt, with a lower ratio being preferable. Some lenders require a sufficient debt-to-income (DTI) ratio to approve loans. For example, if you earn $8,000 per month and have $2,000 in monthly debt payments, your DTI ratio would be 25%.

Reviewing these numbers provides a clearer perspective on your financial well-being, but other methods can also offer valuable insights.

Essential Personal Finance Metrics for Assessing Your Financial Health

Personal finance metrics provide a snapshot of your financial health and help you gauge your progress. Here are some key ratios and metrics to consider:

Personal Finance Ratios and Metrics

FICO Score

Your credit score is a critical number that financial institutions consider when approving loans. It ranges from 300 to 850, with a higher FICO score helping you secure lower interest rates and larger loan amounts.

Credit Utilization Ratio

This ratio measures how much you have borrowed against your credit limit. For instance, if you have a $5,000 limit and have borrowed $1,000 from it, you have a 20% credit utilization ratio. Keeping your credit utilization ratio below 30% will improve your credit score. The best results occur when your credit utilization ratio is below 10%.

Income

Your income includes the money you earn from your full-time job, side hustles and other work-related opportunities.

Expenses

The amount you spend each month is crucial to your financial health. The key to financial well-being is earning more than you spend. Expanding this gap allows you to invest more and achieve your financial goals sooner.

Understanding Your Budgeting and Expense Analysis

A budgeting and expense analysis involves reviewing how you spend your money each month. To perform this analysis, list out all your income and purchases, including necessities like food and housing, as well as discretionary items like dining out, gym memberships or leisure shopping. You can also review your bank account and credit card statements to see where your money goes.

Creating a spreadsheet to track your monthly expenses over time is also a good idea, including expenses that occur periodically, such as replacing car tires or paying property taxes. Regularly running a budget analysis by checking your documents can help you verify if you are on the right path or need to make adjustments. It can also help distinguish between needs and wants. If you find yourself breaking even or short at the end of the month, this budget will show you where to cut to reach your financial goals. Remember to factor in investing as part of your monthly expenses.

Establishing a personal balance sheet and implementing a prudent budget are foundational to improving one’s financial health. Whether you are a recent college grad embarking on a new career, a young adult starting a family or a middle-aged individual looking to improve your retirement outlook, implementing these measures are critical. They underpin all other aspects of financial wellness.

Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting Professional

Thomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.

Setting Realistic Financial Goals

Setting financial goals is an effective way to chart progress, stay focused and achieve meaningful results. A balanced mix of short-term and long-term financial goals can enhance your financial health and bring you closer to retirement.

However, it’s important to avoid setting unrealistic goals that may undermine your motivation. The best goals are reasonable yet challenging. Short-term goals should be attainable within the next few months to a year, while long-term goals are more ambitious. Then, list the actions needed to achieve each goal.

Here are some examples of short-term and long-term goals:

Short-Term Goals

• Pay off all credit card debt within 6-12 months
• Accumulate 3-6 months’ worth of monthly living expenses in an emergency fund
• Make an extra $500 per month with a side hustle

Long-Term Goals

• Build a nest egg of at least 25 times your annual income
• Advance in your career to achieve retirement goals sooner
• Obtain comprehensive insurance policies that offer sufficient coverage

Some goals are more important than others. Prioritize attainable goals that will have the most significant impact on your finances.

The 5 Essential Components of a Comprehensive Financial Plan

Creating a solid financial plan is essential for long-term stability and peace of mind. By focusing on key components like savings, debt management, investments, insurance coverage and estate planning, you can build a comprehensive strategy that supports your financial goals and protects your future.

Savings and Emergency Fund

Building an emergency fund helps you navigate financial obstacles. Your emergency fund should cover at least six months of living expenses and should only be used for genuine emergencies, such as job loss or unexpected medical bills.

Using a high-yield savings account for your emergency fund allows your money to grow over time. Allocating a percentage of each paycheck to this savings account will help you gradually build up the fund.

Debt Management

Effective debt evaluation and a repayment strategy can enhance your financial well-being. This process involves outlining your financial obligations and planning your path forward. Most people use either the debt snowball or avalanche method to pay off their debt.

The debt snowball method focuses on paying off the smallest debts first to achieve quick wins and boost motivation. While this approach can improve your mindset, the avalanche method is generally more effective for reducing debt faster. The avalanche method prioritizes debts with the highest interest rates, helping you minimize the total interest paid and slow the growth of your remaining debt.

Investment and Retirement Planning

Investing can accelerate progress toward your goals, though each asset carries risk. Growth stocks, for example, may yield substantial gains exceeding the S&P 500 but can also experience sharp declines during volatile periods.

Certificates of deposit (CDs) come with minimal risk. You’ll earn interest on the money you deposit into a CD, though this account doesn’t grow quickly. Investors should determine their risk tolerance before buying any assets. Your risk tolerance will change over time as you approach retirement. Investors planning to retire within a few years tend to choose less risky investments, while those with several decades until retirement may consider growth-oriented assets.

Many brokerage firms, such as Vanguard and Fidelity, provide tools to monitor your risk tolerance. Additionally, your brokerage account should feature a dashboard that tracks your portfolio’s performance over time and compares it to benchmarks like the S&P 500.

Investing is just one part of retirement readiness. Another important component is knowing when you want to retire. Having a target retirement age can motivate you to save and invest more, helping you get closer to your goal. You should also determine how much money you’ll need to live comfortably in retirement.

Insurance Coverage

Insurance policies can give you and your family extra coverage if needed. You can review your coverage amounts to determine if your insurance policies need modifications. Reducing coverage will lower your monthly premiums, but you may also have to pay more out-of-pocket if you need to file a claim.

You likely already have various insurance policies, including life, health and property insurance. Additionally, long-term care and disability insurance may be necessary. A thorough financial assessment should encompass these policies to ensure your overall financial well-being.

Estate Planning

Estate planning ensures that your assets are properly passed on to your heirs when the time comes. Reviewing your will and power of attorney is an important part of your financial assessment.

You’re more likely to be prepared if you follow these estate planning steps:

Estate Planning Steps

• List your assets
• Identify your heirs and directives
• Seek professional help
• Review your state’s estate tax laws
• Periodically review your estate plan

Keeping Your Financial Plan on Track

Every financial plan requires adjustments as your objectives and progress evolve. Conducting a quarterly review helps keep you on track and allows for necessary changes.

Regularly reviewing key accounts, such as your savings account, brokerage account and insurance policies, provides a snapshot of your financial health. Keeping this information easily accessible simplifies the process of making adjustments.

You shouldn’t leave your finances to chance. Creating a plan and conducting regular financial assessments are important for achieving your long-term goals. With several moving parts in financial well-being, taking proactive steps ensures you’re heading in the right direction. You don’t need to address everything at once; instead, allocate one day for a debt evaluation and another for a detailed budget analysis.

By tackling these tasks incrementally, you can perform a thorough financial assessment and stay on top of your money. This approach makes your financial goals feel more attainable and helps you maintain control over your financial future.