Financial Health: Definition and How to Measure and Improve It

What Is Financial Health?

Financial health is a term used to describe the state of one's personal monetary affairs. There are many dimensions to financial health, like savings, retirement, and expenditure. These factors can be analyzed by looking at indicators such as net worth, budgeting, emergency funds, and debt management. By understanding financial health, people can achieve personal financial goals.

Delving Deeper into Financial Health

Financial experts have guidelines for financial health indicators, but everyone's situation is unique. It's important to create a personal financial plan to meet your goals and avoid unnecessary risks.

Assessing Your Financial Health

To better understand your financial health, consider asking yourself a few key questions as a self-assessment:

• How prepared are you for unexpected events? Do you have an emergency fund?
• What is your net worth? Is it positive or negative?
• Do you have the things you need in life? How about the things you want?
• What percent of your debt would you consider high-interest, such as credit cards? Is it more than 50%?
• Are you actively saving for retirement? Do you feel you’re on track to meet your long-term goal? 
• Do you have enough insurance coverage—whether it be health or life?

Key Factors that Determine Financial Health

An individual’s financial health can be measured in a number of ways. A person’s savings and overall net worth represent the monetary resources at their disposal for current or future use. These can be affected by debt, such as credit card debt, mortgages, and auto and student loans. Financial health can change due to a person's liquidity, assets, and changes in the prices of goods and services.

While a salary might stay the same, costs like gasoline, food, and tuition can rise. If these rising costs aren't managed, financial health can decline.

Typical signs of strong financial health include a steady flow of income, rare changes in expenses, strong returns on investments that have been made, and a cash balance that is growing and is on track to continue to grow.

Strategies to Enhance Your Financial Health

To improve your financial health you must first take a hard, realistic look at where you are currently. Calculate your net worth and figure out where you stand. This includes tallying up everything you own, such as retirement accounts, vehicles, and other assets, and subtracting any and all debts.

Budgeting

Next, you need to create a budget. With your budget, it’s not enough just to plan for where you will be spending: you must also take a close look at where you already spend. Are there areas where you could cut back? Recurring subscriptions that you don’t really need—such as cable? Distinguishing between your “needs” (mortgage, food, utilities, transportation) and your “wants” (gym memberships, dining out, your morning latte) can help you identify items in your budget that are more expendable.

Use spreadsheets or mobile apps to help set up a budget. Or, use the time-tested envelope method, which involves creating an envelope for each budget item, such as groceries, and keeping the allocated cash for it in the respective envelope. Then, when you do your food shopping, you take money out of that envelope.

To stay on budget, stick to your plan even if your income rises. Increased spending when earning more, known as lifestyle creep, can harm financial health.

Emergency Fund

Building an emergency fund can materially boost your financial health. The fund is meant to be money that you've saved and that is readily available for emergencies, such as car repairs or a job loss. The goal should be to have three to six months’ worth of living expenses in your emergency fund.

Debt

Debt can interfere with your financial health, so it's important to pay it down as quickly as you can. Use either the avalanche or the snowball method. The avalanche method suggests paying as much as possible toward the highest-interest debt while paying the minimum on all others. The snowball, meanwhile, suggests taking the smallest debt balance first and then working your way up to the largest debt. There are pros and cons to each; pick the one that works the best for your debt load and your money-handling preferences.

Retirement

Many Americans are inadequately prepared for retirement. According to a 2024 AARP survey, 20% of those age 50+ had no retirement savings and more than half were worried that they didn't have enough saved to see them through retirement. Having enough money to retire takes planning. In general, the earlier you start to save for your post-work life, the better, so your money has time to grow. If you have a workplace retirement plan with an employer match, try to save at least as much as is needed to receive the match. Also, consider opening an individual retirement account (IRA) to put away additional funds.

Essential Tips for Maintaining Financial Health

When it comes to effective personal finance, keeping your financial health in tip-top shape isn’t always easy. We get caught up with living life. However, here are a few quick rules and tips that you can follow to either maintain or improve your financial health.

• Automate your bill payments and savings—that is, set up automatic transfers to a savings account and auto-pay all your bills.
• Always look for free checking and free accounts.
• Shop around for insurance, cable, and other recurring expenses, even if you already have these items.
• Use a budgeting method, such as the 50/30/20 rule, which suggests you should be spending 50% of your income on needs, 30% on wants, and 20% on savings. This 20% could include debt reduction if you have high-interest debts.
• Try to limit spending on housing (rent or mortgage, not including utilities) to no more than 25% of your income.
• Invest early and often. Try to put at least 15% of your income directly into a retirement account.

Understanding Business Financial Health

The financial health of businesses can be gauged by comparable factors to assess the viability of a company as a going concern. For instance, if a company has revenue coming in and cash in the bank, yet is spending its resources on new investments in production equipment, office space, new hires, and other business services, it may raise questions about the long-term financial health and survivability of the company.

Spending money without contributing to a business's stability or growth can make it hard to cover expenses like utilities and salaries. This might force pay freezes or cuts to keep the business running.

The Bottom Line

Good financial health means that you are successfully managing all the facets of your financial life. It takes work to stay on top of your finances as you go through life and meet your changing needs and goals, such college education for your kids, home ownership, and travel. It's important to invest money in retirement funds for your future, including in a workplace plan like a 401(k) as well as individual retirement accounts. Meeting with a financial planner can help you strategize for all of your goals.