Your financial health is important, just like your physical health. We can measure our physical health quite easily by comparing ourselves to others or by the way we feel. Did you sleep, eat and exercise well? These are simple questions to answer.
Financial health is slightly more tricky. We don’t go around comparing our savings accounts or speaking about our emergency fund to a random person. Sometimes being less “personal” with our personal finances might aid us in managing our money better. But this is more easily said than done.
Doing a financial health check can help us make quick adjustments to our lives – from spending to saving to earning. Plus, being aware of your financial health is critical because if you’re financially ‘sick’, your recovery time will take much longer than if you’re suffering from the flu! So, we’ve put together 3 metrics to assess your financial health. Let’s begin with looking at your net worth.
1. What’s the change in your net worth (or net value)?
Knowing your net worth isn’t reserved for the Forbes Top 100 Wealthiest. It can be used to determine your financial standing quickly. It’s calculated by simply adding up the value of your assets and subtracting the value of your liabilities.
A liability is something you owe to someone else i.e. a debt. Things likes home loans, credit card debt, store cards and student loans are liabilities. Your assets would include things like your home, the cash in all your accounts, savings, investments and your vehicles.
We’re all running our own race with different starting points so comparing your net worth to others may be unhelpful but the direction your net worth is moving in is important. Don’t stress about having a negative net worth. Many people do. You’re already one step closer to changing this by knowing where you are.
Increase your net worth on an monthly basis by saving or investing more and paying down your debt. Before you know it, you may have enough to be financially free.
2. What’s your debt-to-income ratio?
Your debt-to-income ratio indicates how much of your hard earned income is going to pay off debt. It’s calculated by taking the amount you pay towards debt per month divided by your monthly gross income.
Keep your debt-to-income ratio below 36% – the lower the better. This is because it’s important be in control of your debts. 22seveners have a debt-to-income ratio of 34%, while the South African average is 72%. You can get closer to 36% if you’re taking out a home loan – known as good debt. Banks will typically limit your home loan repayment to 30% of your gross income. Remember, your car loses value over time so the lower your car finance, the better.
If your debt-to-income ratio is high, aggressively pay down your bad debt (i.e. short term, expensive debt with an interest rate greater than 12% (most likely credit card debt) and then tackle your good debt. Taking on any form of bad debt isn’t advisable, but having good debt and a plan to repay it is part of healthy financial behaviour.
3. How many months’ expenses do you have saved in emergency savings?
Emergency funds, or rainy day funds, are critical to protect your financial health. If you’re in an accident, you’ll need to pay for repairs or at minimum, the excess on your car insurance. You may have emergency medical costs or you may be retrenched. It’s recommended that you have at least 3 months’ expenses saved in an account earning inflation-beating interest. Building this fund should be your aim before investing.
Does 3 months’ expenses sound daunting? Set intermediate milestones e.g. Aim to save R5,000, then R10,000, then 1 month’s expenses etc. If you put 20% of your income to emergency savings each month, you could build up a big enough fund in a year.
These metrics give you the baseline of where you’re at. A financial doctor, if that were a thing, would perform these tests to assess your financial health. They would also recommend you have an overview of all your inflows and outflows, neatly presented in an app which allows you to track your money, automate your budget and gain insight into your finances. We’d prescribe 22seven 😉