What is financial health?
Financial health is the state and stability of your monetary affairs. There are many factors contributing to healthy financial situation. Some of the strongest indicators of financial health are:
- steady, strong flow of income,
- steady expenses,
- the ability to regularly save,
- having a growing cash balance
- and strong return on investments.
How to evaluate your financial situation?
To better understand your financial situation, carry out a self-assessment and answer these key questions:
- Do you have an emergency fund? An emergency fund is cash money that is sitting in a bank, preferably in a high-interest savings account and you can easily access it in case of an emergency. It should typically contain six months’ worth of your living expenses. This money should only be spent in extreme situations such as job loss or serious health issues.
- What is your net worth? Is it positive or negative?
- Do you have any high interest debt, such as credit cards? What percentage of your debt is high-interest debt? Is it more than 50% of your total debt?
- Are you saving for retirement?
- Do you have the things you need in life? How about the things you want?
- Do you have a budget to reach your financial goals?
What is net worth and how to calculate it?
Net worth is the difference between what you own ( a house, a car, jewellery, investments, cash in the bank) and what you owe (your mortgage, your credit card debt, student and personal loans). In other words, your net worth equals:
Net worth = YOUR ASSETS minus YOUR LIABILITIES
This is an example of a person’s net worth calculation:
Assets: things that you own:
A house: $1,000,000
A Car: $20,000
A business: $300,000
Total Assets: $1,320,000
Debt: things that you owe:
Mortgage: $500,000
Loan: $150,000
Credit cards: $2,000
Total Debt: $652,000
Net worth is: $1,320,000 – $652,000 = $668,000
Challenges to calculating your net worth:
There are certain challenges to calculating your net worth. One of the biggest mistakes people make when calculating their net worth is assign incorrect values to their assets. It’s important to make careful estimates when placing value on certain assets in order to avoid inflating your net worth because you don’t want to have an unrealistic view of your financial situation. Your home, for example, is probably your most valuable asset and can change your financial situation a lot. You can correctly calculate the value of your house by comparing it to similar homes in your area rather than just by guessing it.
Be sure to do some research when evaluating the value of your assets. Also, take a good look at your debt as well. Checking your mortgage statement, for example, is a good idea.
Why knowing your net worth is so important:
Knowing your net worth is important for many reasons. First of all, the number that you receive as a result of the calculation can tell you many things about your financial situation. If the number is negative, it tells you that you owe more than you own. If the number is positive, you know that you own more than you owe. It shows you what your financial situation is and prompts you to change your financial habits. If your liabilities exceed your assets, it doesn’t necessarily mean that you are irresponsible. It may, for instance, mean that you have just started paying off your mortgage, or that you are young and haven’t acquired important assets yet. However, knowing your net worth definitely shows you the trend that your financial decisions should be aiming for.
Knowing your net worth may also be useful when trying to secure loans for additional investments. The more equity you have in your house, for instance, the more likely the banks are going to be to give you another mortgage. The more investment properties you own, the easier it will be to get additional loans.
Last but not least, knowing your net worth may push you towards being more responsible with your money and setting up a budget to achieve your financial goals. It could be a vital motivator and a self- assessment tool when evaluating your financial situation.
Calculating your target net worth:
Target net worth is the ideal net worth for a person at a particular age. It is a starting point at establishing the net worth that you want to get. It is frequently used by people who have no idea where to start and can be adjusted to your needs and wants. It is as follows:
Target Net Worth = [Your Age−25]∗[1 / 5∗Gross Annual Income]
To use this calculation, a 45-year-old with and annual gross income of $65,000 could be aiming for a net worth of $260,000.
[45-25] * [65,000/5] = $260,000
Of course, this number is just a suggestion. You may aim for a higher amount depending on your goals.
How to improve your financial situation:
Being on track with your financial goals isn’t always easy, but here are a few quick tips to make it manageable:
- Automate your bill payments. Set up automatic withdrawals from your checking account to pay your bills. If you forget to pay your bills, you will be charged a late fee, you may experience a service interruption and ruin your credit score.
- Automate your savings, that is, set up automatic transfers to a savings account. That way you will never spend your savings away before they hit your savings account.
- Automate your investments. Set up automatic transfers from your savings account to your investment account.
- Get free checking accounts.
- Shop around for insurance, cable or and other recurring expenses. Preferably, change services often to avoid augmented fees.
- Create a budget. You can use a budgeting method, such as 50/30/20. It assigns 50% of what you make to your needs, 30% to wants and 20% to your savings. This 20% could be put towards debt reduction if you have high-interest debts, for example credit cards.
- Do not spend more than 40% of your income on mortgage or rent.
- Put 10-15% of your income into your retirement account or invest it in real estate. You can also invest in gold or stocks that have done fairly well over the years.
