Definition and Examples of Financial Health
The World Health Organization (WHO) defines health as “...a state of complete physical, mental, and social well-being and not merely the absence of disease or infirmity.”
With that in mind, financial health can be defined as the state of well-being of a person, business, or institution’s finances. It’s important to understand that, as with your regular health, your financial health is not merely based on the absence of things like debt. It takes many factors into consideration.
For instance, much like the way physicians measure physical health with metrics like blood pressure or body mass index (BMI), you can measure your financial health with metrics like your credit score, debt-to-income (DTI) ratio, or net worth.
How Financial Health Works
Financial expert and author Emily Guy Birken told The Balance by phone that every individual must look at their own unique financial picture.
“Financial health has a lot of parallels with physical health, in that there is no one single metric that determines health,” she said. “You may not be living paycheck to paycheck, but what are your debts? Do you have insurance? How big is your emergency fund? It can feel like a moving target because there’s not one metric to hit.”
There are several metrics for measuring your financial health. Start by choosing one, such as your credit score or DTI ratio, and then work on improving your financial health.
“If you work on one, it will surely benefit your overall health,” Guy Birkin said. “If you quit smoking, you may gain weight, but it improves your overall health. If you pay off high-interest debt, your cash flow might decrease for a while, but your overall financial health improves.”
Guy Birken said that consumers should think about the metrics used to determine financial health as vital signs. Income is a vital sign of financial health. It’s not necessary to have a high income, but expenses should be less than money earned. Debt can also be a vital sign. A high DTI ratio may be a warning sign that your financial health isn’t that great, while a low ratio may be a sign of good financial health.
Getting to know the metrics used to measure good financial health is one way to start improving and maintaining a state of financial well-being.
What Are the Metrics Used To Measure Financial Health?
The mere ownership of assets is just one metric that can be used to measure financial health. Assets are anything that contributes positively to net worth. Assets can include:
- Money in your emergency savings account
- Investments like shares of stock and mutual funds
- Retirement accounts
- Insurance coverage
Guy Birken said that adequate insurance is one metric that works better as an indicator of ill financial health.
“Driving without car insurance is not a choice made by someone in good financial health,” she said. “If you do not have health insurance, you are in a precarious financial state. And people don’t realize how necessary disability and life insurance are. If you get COVID-19 or pneumonia and you need three months to a year to recover and you don’t have disability insurance, then you’re out of luck.”
There are also metrics that include liabilities in calculating financial well-being. For example, your DTI ratio, which measures how much debt you have in contrast to your income, may be used to calculate your credit score. It can also be looked at on its own, such as when you’re applying for a home loan. Credit scores can also be used as a metric on their own, such as when you’re applying for a credit card or personal loan. Net worth is another metric that may come into play.
For example, if you’re in good financial health, you most likely have a higher credit score. Or maybe your DTI ratio is at or below 36%. Your net worth might also be positive, which means the total of your assets equals more than the total value of your liabilities.
Good financial health means having good financial habits, too. For example, every month you might track your spending in a budget spreadsheet, pay off your credit card balances in full, and save at least 10% to 15% of your income for retirement if you have good financial health.
How You Can Improve Your Financial Health
The best first step in improving your financial health is to track your spending by creating a budget. By knowing exactly how much money you spend, you can more accurately plan to increase your income or cut back on unnecessary expenses if needed.
Once a budget is created, you can set money aside for building an emergency fund and reducing or paying off debt. As you pay down debt, your DTI ratio will go down, while your credit score will go up—all good things for your financial health. With less debt, you may have more disposable income and may be able to afford more insurance.
Once all of those metrics start to improve, add up the value of your assets (like your savings or home equity) and subtract the value of your liabilities from that number (like student loans and mortgage debt). The result is your net worth. You can take steps to improve your net worth, and in doing so, the other metrics will surely improve.
Remember, the point is to choose one or two key metrics, work toward improving them, and your overall financial health will likely improve, too.
Guy Birken said consumers should also remember that the outcome of any metric can be beyond their control.
“There is a sense that if you do everything right, your financial health will be perfect,” she said. “That’s simply not the case. Catastrophes can certainly happen to healthy people. There are going to be things that are out of your control, which is why it is important to do what you can.”
- Financial health is a state of being in which a person, business, or financial institution measures their well-being by the condition of monetary assets and liabilities.
- Financial health can be measured in a variety of ways, such as by looking at your credit score or net worth.
- By improving one metric, you may be able to improve other metrics that are used to determine your financial health, too.
- Like physical health, there may be some things that are just simply outside of your control. This is why it’s important to do what you can to improve and maintain financial health.