Your Financial Health Matters
When we think of our well-being, we often only consider the our physical well-being. Our emotional well-being and mental health are just as, if not more important. Within the realm of mental health lies our financial health. Our financial health is fundamental in living a life free of stress and burden. While there are many ways to evaluate your financial health, many are hesitant to do so because it may be the reality check they probably don’t need right now. A 2019 CNBC article says that almost 78% of US workers live paycheck to paycheck. If 78% of workers couldn’t afford an emergency a year ago, its next to impossible that the number is lower during a global pandemic.
The COVID-19 pandemic has created a host of financial issues for individuals with record levels of unemployment. If you currently have the privilege of working from home during all this, use this time to evaluate your financial health during this time of uncertainty. Let’s talk about what financial health actually is, ways to evaluate it, and ways to improve it.
What is Financial Health?
Ignorance is not bliss in the world of personal finance
Essentially, financial health assesses your capacity to sustain your daily needs as well as your capability to prepare for unexpected emergencies like layoffs or accidents. It’s important to know what emergencies you can cover before times of trouble. This goes beyond just logging into your all your bank accounts and adding numbers up, but I promise you the few minutes you spend today evaluating your financial health will help you should a financial emergency come your way.
Net Worth
Your net worth is a great place to start when you evaluate your financial health. Your net worth is what’s left over after subtracting your liabilities (debts) from your assets. Assets are essentially anything that you own and can be converted into cash, like your bank accounts, investments, electronics, jewelry, etc. Liabilities are any debts that you owe. Most of the people reading this probably have an extraordinary amount of student debt. With higher education costs rising astronomically year over year, students are forced to take on debt at such a young age leaving them financially vulnerable when they start their careers post-graduation. A CNBC article states that “over 44 million Americans collectively hold nearly $1.5 trillion in student debt. As a result of this, many young Americans have a negative net worth for their 20’s and 30’s at minimum.
Your net worth is a snapshot of your financial position at a certain time, but personal finance, and financial health in particular is about long-term health. The best way to utilize viewing your net worth is to track it over a long period of time. Luckily, this doesn’t take a lot of work. You can create a spreadsheet or just use Personal Capital.
Don’t be discouraged by a negative net worth, it doesn’t mean you’re financially irresponsible. One data point can’t possibly tell the whole story. Remember, progress isn’t immediate. Remain consistent with your tracking, and you will begin to see improvements.
Savings Rate
Your savings rate is one of the most important measures of your financial health. Your savings rate can be expressed as a percentage of your total remaining income after paying for all your expenses. Similar to your net worth, your savings rate is important to track because one data point does not tell the whole story. It’s important to track this often as well, once a month is the typical time to track this.
If you have a monthly income of $5000, and your total savings for the month were $3000, then your savings rate for the month is 60% (3,000/$5,000= 60%). Not every month will be the same, but if you start to track it monthly consistently, you’ll be able to find your general average savings rate which can help you create realistic and effective savings goals. While saving money is a goal we all want to achieve, it’s easier to do when we have the right tools to help us get there.
Housing Ratio
Your housing ratio is another quick and easy way to evaluate where your money is going. Your housing ratio is the percentage of your total monthly income dedicated to all household expenses. If you’re a renter, household expenses are your rent, utilities, and renters insurance if you have that. If you’re a homeowner, your household expenses are your mortgage, any insurance, taxes, and utilities.
Your housing ratio is used by lenders to see how qualified you are for a home loan. Generally, lenders prefer your housing ratio to be 28% or lower in order to be approved for a mortgage.
If your monthly income is $3,500 and your monthly household expenses are $1,200, then your housing ratio is about 34%. You can also use this to see how much rent you can afford if you are looking for a new place.
If you live in a high cost-of-living area like I do (NYC), its pretty much impossible to find a a home or apartment that only costs 28% of your monthly income, so don’t live and die on this number. It’s merely a tool to evaluate your current financial position. Your application for a rental won’t necessarily be rejected if your ratio is above 28%, it’s just a good rule of thumb to make you’re on par with your savings and spending goals.
Credit Score
Your credit score is a big part of your credit profile. While a couple paragraphs is definitely not enough to talk about all the factors of a credit score, let’s review the basics! Your credit score is a number generated by credit bureaus to evaluate your creditworthiness. There are three major credit bureaus in the United States, TransUnion, Equifax, and Experian. First, let’s see how your score is calculated. For reference, credit scores range from 300 to 850, with 850 being the best possible score.
Credit scores are calculated using:
- Payment History (35% of your score)
- Total Amount Owed (30%)
- Length of Credit History (15%)
- Types of Credit (10%)
- New Credit (10%)
Your payment history is a collection of all the payments that you have made to pay off your debts as well as the timeliness of your payments. This is the largest portion of your credit score, so the more often that you make on-time payments the higher your score will be.
Your total amount owed is essentially how much of you available credit you use. If you have a credit card, you probably have a credit limit. Let’s say your credit card limit is $1000. Generally speaking, utilizing more than 30% ($300) of that will negatively affect your score.
A longer length of credit history is great for your credit score since there is more data available to evaluate your payment history.
Types of credits refers to the different account credit accout types associated with your credit profile (mortgage, auto loan, student loan, credit cards)
New credit is the amount of new credit accounts you have opened recentley. Having many recently opened accoutns will likely negatively affect your score for a short amount of time.
Here’s a general breakdown of credit score classifications:
- Excellent — 800–850
- Very Good — 740–799
- Good — 670–739
- Fair — 580–669
- Poor — 300–579
Your credit score is important for many reasons. Mainly, it helps determine the interest rate you pay for borrowing money from a lender. A percent or even half a percent lower can mean thousands of dollars in interest savings on a loan, so it’s vital that we keep track of our credit score over time and ensure that the info on your credit profile/report is up to date and accurate.
To check your credit report, you can visit the credit bureaus site and request a free report once a year. You can stagger your requests so that you get one report from a credit bureau every 4 months!
Liquidity Ratio
Your liquidity ratio is a quick way to assess your current ability to financially sustain yourself during a financial emergency. You can divide all available cash and cash equivalents by your total monthly expenses to see how many months you can sustain yourself financially. For example, if you have $5,000 in cash and your typical monthly expenses are $2,000, your liquidity ratio is 2.5, which means you have enough cash to cover 2.5 months worth of expenses.
Emergency Fund
An emergency fund is a powerful tool to have in your financial arsenal. If you have to deal with an unexpected expense, your go-to will probably be your emergency fund. An emergency fund is a bank account set aside for large, unexpected expenses like car damage, medical expenses, or a layoff. Having an emergency fund is vital to feeling like you’re financially secure. Shit happens, and an emergency fund is something you build to make sure that the financial stresses of an unexpected emergency don’t overwhelm you. Typically, a good amount to keep in this bank account is about 3–6 months of expenses.
If putting aside 3–6 months of expenses aside in a separate bank account for the possibility of a financial emergency sounds crazy and unattainable, I don’t blame you. After graduating with by bachelors degree, I did very minimal saving. The small amount of money that wasn’t spent on necessities and student loans just sat in a checking account. I had never heard of or even considered an emergency fund of 3–6 months. That’s way too much money. But as I started to learn more about being smart with money and setting personal goals, I had unknowingly saved about a month’s worth of expenses. My point is, it’s not a race. Nobody should expect to save thousands of dollars overnight, its a gradual goal that you slowly build towards. As long as you remain disciplined financially, you control your own pace. One of the many ways to build an emergency savings fund is to incorporate savings into your budgeting using the 50/30/20 Rule.
The 50/30/20 Rule
The 50/30/20 Rule is a popular budgeting methods that incorporates savings into your budget. While the word “budget” brings fear into our hearts, it can be an extremely effective tool. The rule allocates your money into needs (50%), wants (30%), and savings (20%)
Your needs are the bills and necessities you require to live, like your rent/mortgage, utilities, food, medication, insurance, and the minimum payments for any debt you hold. Before you ask, no, Netflix is not a need 🙂
Your wants are those nice-to-have’s but are not necessities in your day-to day life. This includes entertainment, dining out, clothing, makeup, etc. traveling. It’s important that you incorporate your wants into a budget. Not only does it make your budget more realistic, it reduces the intimidation the word budget carries. It’s important for your financial and mental health that you can enjoy life. Budgeting should never be about solely cutting expenses just to grow your bank account.
The remaining 20% should be allocated to your savings accounts. This can be your bank accounts, investment accounts, or retirement accounts. Additionally, debt repayment can also be a part of your 20%. While the minimum payment is allocated to your “needs”, anything extra that you pay on top of that can be considered your savings since you are actually savings money by paying less interest on the principal amount that you borrowed.
Final Thoughts
None of these numbers are set in stone. Personal finance is about YOU, so do what works for you, but use this as a template if you feel stuck financially. Not everyone has the privilege to save save a lot of money, especially during a pandemic in which fear, stress, and anxiety are continually rising. Remember that you control your own pace. Remain calm and positive. Set realistic goals for yourself and you will see your personal finances take flight.
This is a story from Runway Finance, a blog that explains financial concepts from a practical, approachable, and helpful lens. Thanks for reading!
