Financial health check-ups
In this article, we will deal with the financial health score and the steps to become financially healthy.
What Is Financial Health?
In this article
Financial Health describes the state of one’s personal monetary affairs. How can a person deal in case of unexpected financial emergencies? It is not just this; it has many other dimensions such as the amount he has for savings, money put aside for retirement, etc.
People with poor financial health have specific characteristics such as low credit score, very little or no savings, no management of money, etc. This can put you as well as your dependents on risk. Such people have no backup in case of unforeseen job loss.
Whereas people with good financial health save each month, have a good credit score, closely monitor their investments, and have a good grasp on their income.
How Is Financial Health Score Determined?
The financial health score is static; it changes even after a small change in your budget or expenditure. The person’s savings, cash, and investments represent his net worth, which can be used by him later on, which increases his/her financial health, Whereas factors such as debt, example: – credit card loans, home loans, student loans, tend to decrease them.
If your budget, expenditure, and investments are constant, still there is a possibility of your financial health decreasing because of the inflation or surge in the price of petrol, diesel, food, shelter, etc. In such cases, you lose control over your financial health and decline their financial goals.
To determine your financial health, you can self assess by asking the following questions: –
- How prepared am I for unexpected events?
- What is my net worth? Is it positive or negative?
- What percentage of my debt is high-interest debt? Is the debt percentage greater than 50%?
- Are you actively saving for retirement?
- Do you have enough insurance coverage for health and life?
What Is Meant By Financially Healthy Person?
A person having enough net worth to fulfill all his requirements in case of unforeseen events.
i. Robust Net Worth
When the net worth of the person grows at a steady rate, is said as robust. The speed for an increase in wealth should be enough to fund all the planned life goals/ priorities for life.
Setting up life priority is very important in case you want a financially healthy life. These priorities/ financial goals are very important, so do it as soon as possible and be sure to make a precise list about it. Interpretation of financial health can be done concerning the achievements of these goals.
Making a list of priorities is very important; once you have a precise list with all the goals and the timeline, start working for it. If you have a high net worth, but your net worth does not complete the financial goals, you are still not financially wealthy.
How To Become Financially Wealthy?
Becoming financially wealthy is a process, a process everyone needs to follow. Once you have lined up your goals in order with the timeline for achieving it. You can go for fee-based financial planning to keep going.
You need to be disciplined and sacrifice a lot to achieve what others haven’t.
We give a list of 6 steps following which one can increase their financial health score.
Start your journey to increase your financial health score by writing down your budget.
Budget is an essential aspect for us to have a stress free life. While making a budget, make a precise calculation of the expenditure you are going to have throughout the month.
The budget should include the necessary expenses such as food, transportation, rents, EMI’s, etc.
The budget should flow in mainly three routes: –
i. Expense Route
The maximum amount you should spend monthly should not be more than 50% of your total earnings. This money should complete your household expenses. You have to avoid overspending and do not make any blunders while spending.
ii. Investment Route
In this segment, you should invest around 30-35% of your monthly earning in different places. Investing through SIP can help you a lot, as you don’t need to put a lump sum amount. Try to diversify your investments so that in case of market fluctuations, your investment is safe and secure.
iii. Emergency Fund Ratio
After you have put your money in investments, you also need to have around 15% of your income as an emergency back up in case of unforeseen expenditure. You can pile this up and use only when there is an urgent need for money.If you manage your income in such a way that it fulfills all the three mentioned rules, then you have completed the first step for building your financial health score.
2. Build Cushion Savings
We are humans and our urge to spend money is endless. The more we will earn, the more it will be our urge to finish it. So to prevent that, we need to build cushion savings.
Cushion savings act as a buffer between our income and our spending. People overspending in this regard is high, so we need to have a closer look at how we are spending money.
To prevent overspending, we can
i. Manage Cushion Savings
Cushion savings have accumulated a stack of money. They are 6 months of your monthly expenditure.
You need to make sure that the level of cushion savings does not fall below the 6-month expenses and you shall only withdraw about 50% of your income each month.
To build cushion savings, the 50% you were going to invest and keep as an emergency fund, but neglect it and then put it in cushion savings. It will take you 6 months to build it, and then you shall continue with the investments and emergency funds.
If one month you over-spent, then the following month, you should reduce your expenditure and compensate there, and if your monthly expenses have risen, then your cushion savings should also increase.
ii. Income Debt Ratio
Always have a look at your income to debt ratio, because the increase in debt can easily ruin your finances.
To calculate your income to debt ratio, find out the amount you pay as an EMI and then divide it by the total gross income.
Ideally, your income to debt ratio should never get above 30%, because then you would be under the immense burden of paying out the EMIs and you won’t be able to invest and save properly.
3. Build Emergency Fund
What will you need if you are met with an unforeseen situation, where you need a good pool of funds. This can be medical conditions, pandemic, sudden death, job loss, etc.
Before you try and invest in more volatile investments such as stocks, you need to have an emergency fund. Your investments can backfire and you can lose all your investments, so you should have enough money to carry on your household activities.
An emergency fund is a combination of liquid assets and insurance cover.
i. Liquid Asset
These are the cash deposit in the form of a fixed deposit. These can be anything but should be greater than 6 months. The funds shall be only used in case of unforeseen expenditures. When you remove a particular amount, save it from the income next month and put it back in the emergency funds.
ii. Insurance Cover
A person should have both life and medical insurance. These medical and health cover helps a person in case of unexpected events. The medical cover should be approx. 6 months of current income and life cover should be around 10 years of your income.
Putting away all the savings for some unexpected events is not at all worthy, so if you have emergency funds for you, then your life will be easier.
4. Finalize Your Financial Goals
Financial goals are the goals which you want to achieve at the priority, then the other luxuries can come if you achieve them before time
You are still behind the clock if you haven’t decided on your financial goals. Start noting them now!
When you write down your financial goals, make it precise with the exact amount and timeline for the same. The timeline can include when you will start investing for it, when you will stop investing for the goal, when the goal will come in handy, etc.
To achieve your financial goal, the basic thing you need to do is, Invest. Only investing will help you achieve your financial goals.
For example, in any normal circumstances, you can have four primary financial goals, first being car purchase aiming at a short span, the purchase of a house with a higher sum of money for like 5-10 years, then save for your children with savings in the range of 30-50 lakhs for a span of 15 years and the retirement fund anywhere in the range of 2-5 crores.
5. Invest To Accumulate Assets
We learned above that we need to invest, but why do we need to invest? We invest to accumulate assets.
Assets are anything owned by you which has a particular value. It can be property, stocks, fixed deposits, funds, etc. But we should always strive to accumulate quality assets.
There are two types of quality assets, Fixed Income asset; this type of assets gives a fixed yield for a particular amount of time. Their credibility and returns make them a quality asset. Second Capital Appreciating assets, unlike the fixed income asset they are known to give a higher amount of returns in lesser time. The quality of these assets depends upon the price valuation and the strength of the assets.
Your investment strategy also depends upon your risk profile. If you are a risk-taker then you will invest the majority of your money in capital appreciating assets or in equity-related instruments and if you want to play your investments safe then your majority amount can go in accumulating assets bearing low or no risk.
6. Determine Your Net Worth
You should also have a figure of assets and liabilities. This will help you find your net worth.
Your net worth is increased by assets and decreased by liability.
If your net worth is positive an is increasing, then you are on the right path to increase your financial health score
What can be counted as assets
- Money in the savings account.
- Fixed deposits.
- Debt-based mutual funds.
- Equity-based mutual funds.
- Undervalued stocks.
- Real estate property.
- Precious metals (gold, silver), etc.
What can be taken as a liability
Add all the assets to your net worth, i.e whatever assets you have will add up in your net worth. Similarly, the loans, credit card balance has to be decreased from your net worth.
Financial Health Of A Business
The most important areas which determine the financial health of a company is Liquidity, Solvency, profitability, and operating efficiency.
A company having good amounts of cash in hand and pending, and then investing to increase the production, workforce, office space increases its financial health score and gives assurance for long term living
Anything that does not contribute to more stability and potential growth of the business can lead to the decline of the company. The company may then even face difficulties in paying the salaries and carrying out day to day expenses.
More is the profit gained by the company, more is the possibility of the company outliving others.
Signs That Your Financial Health Score Is Decreasing
It is not rocket science to know that your financial health is decreasing, you can self-assess by answering these.
- a. You cannot afford a common financial emergency with your savings.
- b. You have many debts and high credit card balances.
- c. You have a low credit score and have been turned down for credit card application, home loan, jobs, etc.
- d. You don’t worry about money a lot.
- e. You don’t know how much you spend, invest.
- f. You are forced to sake loans at a higher rate due to low credit score.
If more than half of the above-given facts are true for you, then your financial health score is surely decreasing and you need to have a good look at your finances.
People have got better from the worst situation, so start working from the moment you find out and do not lose hope
Can Anyone Achieve Financial Health?
You don’t need to have a six-figure income or you have a load of money in spare to achieve better financial health.
You have to be selective in your spending, have a proper budget, and stick to it. Your investments should be thoughtful, you should invest in capital appreciating assets.
If you have been negligent in the past, don’t worry, now is the time to act. Start now, and you will soon achieve a better financial health score. Your actions in past will not determine your future, so start working right away.
Your finances cannot fix themselves up if you keep being negligent. Consistent focus on your finances and budget will be very important if you are trying to turn over your finances.
Why Investing In Equity Is Best?
Equity is risky, we all know that. But investing in high risks even has a probability of giving you high rewards. Investing smart and investing for the long term in equity will give you very high returns.
Inequity returns of about 12-13% is considered good, but investing patiently for aa long period can also yield you return more than 19-20%.
Equity gives you the convenience to start from as low as 500Rs per month. Even if you have quite high expenses or low earnings, you can still invest in equity.
Investing in equity is very convenient and simple. You can either directly invest in stocks or you can invest through the equity mutual funds. Both are quite similar but there are several equity mutual funds giving lower risk for the same equity.
Tips And Rules For Financial Health
- Automate your bills and investments, this will give you an idea of what you have in hand.
- Use a budgeting method of 50/30/20. 50% expenses, 30% of investments, 20% of emergency expenditure.
- Try to maintain a debt-income ratio of less than 40%.
- Start investing early and invest consistently.
- Invest systematically, invest in mutual funds, do payments via the SIP route, and hold the investments for longer durations.
- Keep track of all your expenses, make a list of your monthly basic expenses, and then stick to it. Avoid overspending, reduce unnecessary expenses.
- Pay yourself first, when you get your income in hand, make sure to take a sizeable amount out of it, and invest in multiple places.
- Never keep all your investments in one basket, diversify it.
- Try to put some amount even in the investments related to retirement.
I think now you have a better understanding of evaluating your financial health score.
Frequently Asked Questions (FAQs)
1. What is financial health?
Financial Health describes the state of one’ personal monetary affairs.
2. How Is Financial Health Score Determined?
Financial health score depends on various factors such as the savings, debt, investments, assets base a person has. It does not have any specific formula but changes with the factors.
3. What is the 50-30-20 rule of budgeting?
Under 50-30-20 rule, 50% per cent expenses, 30% of investments, 20% of emergency expenditure.
4. What are the factors affecting the financial health of a business?
Factors affecting the financial health of the business is Liquidity, Solvency, profitability, and operating efficiency.
5. What should an emergency fund consist of?
An emergency fund should consist of liquid assets and insurance cover.
6. How to calculate income to debt ratio?
To calculate your income to debt ratio, determine the amount you pay as an EMI and then divide it by the total gross income.
7. What are cushion savings?
Cushion savings have accumulated a stack of money. They are basically 6 months of your monthly expenditure.
Which are the three routes where budget flows?
The budget should flow in Investment route, expense route and emergency fund route.
9.What is considered as a liability?
Liabilities are credit card balance, Mortgage (home loan), Car loan, Education loan, Personal loan etc.
10. What is net worth?
The net figure of assets and liabilities is said as net worth. The complete addition of assets and liabilities is said as net worth.
The financial health score is very important for everyone; you need to keep your distances in line, have a good budget, invest sincerely, have an adequate emergency fund, and avoid overspending.
Financial health is a slow and steady process and you achieve a better hold of it with time, but you need to be patient and have a disciplined money management system.