When they hear “financial health,” most people imagine a bag of money. But it involves much more than just amassing a large bank balance.
Below, we discuss what financial health is and how it affects your future, emotional, and physical well-being. Then, we explain how you can measure and achieve it.
Read on for more detailed tips and explanations.
What Is Financial Health?
The definition of financial health is the state of feeling secure and able to manage monetary affairs.
It is key for your overall well-being, including your mental health. Stressing out about the lack of money can even impact your physical wellness.
In turn, your physical and mental health influence your financial security. If you’re not prepared for health emergencies, they can drain your bank account.
Plus, the definition of financial freedom has a subjective component. This means your emotional state impacts how you perceive your financial situation.
Two people with the exact same income and expenses can have opposite perspectives.
The concept is much more complex than it seems.
How Financial Health Works
The definition of economic security contains four main components.
You are financially stable if you:
- are in control of your money;
- have the capacity to handle a financial emergency;
- stay on track with your goals;
- have the flexibility to make choices.
To achieve that, you need an emergency fund, mindful spending habits, a low debt-to-income ratio, and a plan for the future.
We go into more detail about each step below. But first, let’s see how to evaluate your current state.
How to Measure Your Financial Health
To assess your financial stability, you need to calculate your income, expenses, debts, and assets.
In addition to your net worth and perception, you need to consider the following factors.
Debt-To-Income Ratio (DTI)
We can’t define finance without mentioning debt. It is one of the most important indicators of your overall financial health.
To calculate your debt-to-income ratio, simply add up your monthly debts and divide that number by your gross monthly income.
For example, if your monthly debt is $2,200 and your income is $5,500, your DTI will be 40%.
A high DTI can compromise your ability to save, make large purchases, and maintain your lifestyle if you lose your income. This contradicts the definition of financial wellness.
Ideally, you want to keep your debt-to-income ratio below 36%. If it's above that number, you may have trouble qualifying for certain types of credit, such as mortgages.
Credit Score
A credit score is a numerical representation of your creditworthiness. In other words, that’s the lender’s way to define your financial fitness.
Most people don't think about it until they need to borrow money. But it is important for your financial health for several reasons.
A good credit score determines whether the bank will approve your application. On top of that, it can help you get lower interest rates and save you tons of money over time.
Finally, knowing you can get a loan to cover some planned or unexpected big expense can give you peace of mind.
As such, it’s a good idea to start working on your credit score now.
Emergency Fund
An emergency fund is what personal finance is all about. A well-funded account can help you avoid debt and handle a sudden loss of income or unexpected expenses.
How much should you have in your emergency fund?
That depends on your personal circumstances. Generally speaking, you should aim for three to six months of living expenses. That said, some experts recommend a 12-month emergency fund.
It may be hard to build it, but it'll give you security in times of crisis. And after all, the meaning of being financially stable is to have peace of mind.
How to Improve Your Financial Health
Being financially healthy requires discipline and planning, but it is achievable if you're willing to make an effort.
Here’s what you need to do:
Create a Budget and Stick To It
Budgeting is an essential part of the definition of personal finance.
It’s the first step to gaining control of your money. By tracking your income and expenses, you can make informed financial decisions.
There are many different ways to create a budget. Try out a few and find a method that works for you.
Once you have a system in place, you can determine your spending categories, define your goals, and set your priorities.
If you're not sure where to start, check out our budgeting tips for beginners.
Keep Your Debt Under Control
Debt isn't necessarily a bad thing, especially if you make your payments on time. For example, some creditors consider mortgages an indicator of a strong finance profile.
That said, you must only borrow what you can afford to repay and keep your debt-to-credit ratio low.
To achieve that, you need to pay off large amounts of debt as quickly as possible. There are several methods you can use, including the snowball or avalanche debt repayment approaches.
Build an Emergency Fund
As we mentioned, savings are an essential component of financial security.
An emergency fund, in particular, will define your stability in times of infirmities. It will help you cover unexpected expenses without going into debt.
Ideally, you should aim to have enough to cover three to six months of living expenses. If you can swing it, a 12-month emergency fund is even better.
Start Investing for Your Future
Investing is one of the smartest things you can do for your financial health. Instead of losing its value due to inflation, your money will grow.
There are plenty of options out there.
The stock market is great if you want to pursue bigger gains. If you’re more risk-averse, you can choose a safer alternative, like a high-yield retirement account.
Live Within Your Means
Once you start living by the definition of financial health, you may be tempted to spend more money. But if you want your wealth to grow, you can't increase your spending every time you get a raise.
You need to keep making smart financial decisions. Of course, that doesn't mean you can't buy anything. But there are plenty of ways to spend your money wisely.
Wrap Up
What is financial health?
Your net worth, the feeling of security, the ability to handle unexpected situations and secure your future—it’s all that and more.
It’s not something you can achieve overnight, but it is well worth the effort if you want to live a stress-free life.
By following the tips above, you can put yourself on the path to financial success.
With an eye for research, Aleksandra is determined to always get to the bottom of things. If there’s a glitch in the system, she’ll find it and make sure you know about it.
