Your finances are just as much a part of your overall health as your physical and mental health. The question is, are your finances as healthy as they should be?
5 Ways To Measure Your Financial Health
Financial health is extremely underrated and underappreciated by most people. However, it’s something that’s inextricably linked to mental health and, by proxy, your physical health. So if you’re serious about being a healthy person and living a long and happy life, you need to pay attention to your financial health.
Here are some important measurements you can use to evaluate this area of your life:
1. Budget And Cash Flow
Start by looking at your monthly budget and cash flow. (If you don’t already have a budget, now’s a good time to create one and start tracking it regularly.) Your monthly budget doesn’t just tell you how much money you’re spending each month – it tells you where that money is going. And depending on how it’s being utilized, you can get a feel for the health of your finances.
One useful measurement is something financial professionals call the debt-to-income (DTI) ratio. You can calculate your DTI ratio by taking the total amount you pay in debt payments each month and dividing that figure by your monthly gross income. (For example, if your total debt payments are $2,000 and your monthly income is $6,000, your DTI is 33 percent.)
A healthy DTI ratio is 35 percent or lower. If you’re in the 40 to 50 percent range, you’re nearing the danger zone. If you’re above 50 percent, you’re in bad shape and need to take some corrective measures.
You don’t have to be a homeowner to have healthy finances. In fact, a lot of wealthy individuals intentionally choose to rent instead of buy. However, you can tell a lot about your finances by considering whether or not you’re ready to buy a home. In other words, homeownership is a good diagnostic tool. If a lender deems you healthy enough to buy a home, then you’re in good shape.
3. Lifestyle Inflation
Most people earn more in their careers as they get older. And while this increase naturally opens the door for more spending, you have to be careful not to let things get out of control. If spending increases dramatically alongside income, this is known as lifestyle inflation.
“Even though you might be able to pay your bills, lifestyle inflation can be damaging in the long run because it limits your ability to build wealth,” Investopedia notes. “Every extra dollar you spend now means less money later and during retirement, and higher disposable income today doesn’t guarantee higher income in the future.”
If you’re able to tame lifestyle inflation and put most of your increase towards savings, retirement, and other investments, this is a sign that you’re financially disciplined and healthy.
As a very general rule of thumb, you should have 1.5x your annual income saved by age 30, 3x your income saved by age 40, and 5x your income saved by age 50. These aren’t hard and fast numbers, but they do give you some basic guidelines.
To reach these numbers, you should aim to put away between 10-15 percent of your monthly income toward retirement. If you’re having trouble getting there, start by increasing your annual savings amount by one percent each year until you reach 15 percent.
As the old adage goes, you never want to put all of your eggs in one basket. Take a look at your investments and consider how well diversified you are. If everything is in cash, you’re in trouble. If everything is in stocks, you’re in trouble. If everything is in crypto, you’re in trouble.
You need to be diversified. This means spreading your investments out across a variety of asset classes and investment types. A diversified portfolio will ensure you’re able to weather tough financial storms.
Adding It All Up
When you understand how you’re doing financially, you can make proactive decisions about where to go, what to do, and how to properly position yourself for the future. The good thing about financial health – like mental or physical health – is that you can always improve.
However, it won’t happen magically. You’ll have to put in some work and make sound choices. If you’re ready to do that, good things can happen.