What is Financial Health?
In general, financial health is a condition where a person has a stable cash flow, whether in normal time or in an emergency situation, crisis or retirement period. Some factors can influence your financial health such as income, saving, recession, or unfortunate events.
Becoming unhealthy financially can cause financial problems such as having many bad debts, unable to meet monthly expenses or long-term financial goals, and causing psychological problems such as depression. Therefore, knowing your financial health is important.
Have you ever checked your financial health? How often do you do that?
The Benefit of Checking Financial Health Regularly
By knowing the condition of your financial health, you could figure out the parts of personal finance that you need to improve.
Besides, you are able to quickly prevent and fix the problems through evaluating parts of your finance regularly such as figuring out unnecessary spending. And make a saving plan from that. Along with that, it also helps to reduce debts quickly.
The assessment of financial health will make you be careful with your spending and keep you on track of your financial goals.
How to Check-up Your Financial Health?
Indicators of financial health are different among financial experts. And everyone’s financial condition is different from each other.
It is a better idea to develop financial check-up measurements based on your financial plan.
Now here are the 8 general indicators you can adopt into your financial condition to help make an evaluation.
Note for the indicator:
*Net worth = asset – debt (debt can also be defined as a financial obligation that is the liability).
*Ratio can be defined as percentage or proportion.
#1 Saving Ratio
This ratio represents the amount of income that can be saved or invested. The ideal standard of saving ratio is equal or more than 20% of your total income.
#2 Passive Income Ratio
It represents the amount of your passive income compared to your total income. If your passive income ratio is more than 100%, it means that you have gained financial freedom.
Ideally, the amount of passive income is equal to or more than 50% of your total income.
#3 Liquidity Ratio
It is the ability of an asset to be turned quickly and easily into cash. The ideal scale is from 6 to 12.
If the ratio of your liquidity is below 6 it means, you need to change your assets into a more liquid assets such as cash, gold, mutual funds,
#4 Liquid Asset Ratio to Net Worth
This represents the number of liquid assets (cash and other assets equal to cash) compared to the net worth. The ideal standard of your liquid asset ratio is equal to or less than 15% of your net worth.
#5 Debt Ratio to Asset
This represents the comparison between your debt (loan or other liabilities) and assets. The greater the debt ratio to an asset, the higher the possibility to be broke or bankrupt.
If your debt ratio is less than 50% (ideal standard) then the probability to be broke is lower.
#6 Ratio of Debt Payment Ability
It is the amount of income used to pay down your debt installment. The amount is equal to or a maximum of 35% from the income.
This includes the installment of credit cards, unsecured debt, house (KPR), motorbike (KKB), and other liabilities.
#7 Investment Net Worth Ratio to Net Worth
The number of investment assets compared to the net worth. The greater the ratio of asset investment to net worth, the more productive results your money makes.
The amount of the investment asset is equal to or more than 50% of your net worth.
#8 Solvability Ratio
It is the comparison of your net worth to your asset. The higher the solvability ratio, the better your financial condition. It means you have financial health with a lower probability to go bankrupt.
The amount of the net worth is equal to or more than 50% of your assets.
If you haven’t made a financial check-up before, don’t worry.
You can easily get the report of your financial condition from Cek.Finansialku.com or if you have downloaded Finansialku application, just click the menu in the top left and choose financial health check up. It only takes less than 10 minutes to do that.
After getting the result, what are parts of your finance that need improvement?
This can mean cutting down unnecessary spending that drains out your budget such as subscription of TV channel, internet, or other items. Or it might be allocating some of your income to saving or passive income assets.
Given that these 8 ratios are general measurements, feel free to modify it based on your financial plan and condition.
How to Obtain Financial Health
Now that you have figured out your financial condition, let’s see what ways that can help you to have your financial condition in the best shape.
Here are just some of them.
Budget is one of the important parts to get you healthy financially. Creating a budget within your means and sticking with it is a way to improve your financial condition.
Try this popular portion of budgeting 50/30/20 budget, where 50% of your income goes to after-tax income on necessities, a maximum of 30% on saving, investment and debt repayment. And a maximum of 20% on wants.
A budget helps you live within your means. It allows you to keep the record of the expenses so you can evaluate it later. It prevents you from impulse buying and overspending.
You should make it as flexible as possible since the spending and need vary each month. Remember that a budget doesn’t guarantee that you’d be careful about spending. So, be disciplined!
#Saving & Investment
You’ll need two important things to maintain financial health, saving and investment. Saving is a conventional way that enables you to save money for a longer time. Though the return is small with charging fees, saving has a low-risk and is safe.
If you want to keep and make the money work for you, investment is a great tool. It is a means to serve your financial goals. So be sure you set up your goals before making any investment decision.
It can help you accelerate the process of making a profit or keep your money with higher returns.
In general, investment serves two goals: capital gain and cash flow. Having an investment can make your financial condition stable.
The ideal standard of saving ratio is equal or more than 20% of your total income. And the amount of the investment asset is equal to or more than 50% of your net worth.
An emergency fund is money that is saved for an emergency or an unpredictable situation. Losing a job, health problems or other financial pitfalls are conditions that require you to withdraw cash.
Recently we noticed that Coronavirus (Covid) is spreading so fast that this pandemic caused panic buying and isolation for people. Business is slowing down and the stock market experience crashes.
In this situation, having an emergency fund is important to pay down monthly necessities especially groceries, medication, and rent.
By having an emergency fund, you are less exposed to financial loss and can maintain the cash flow. It also keeps you from having a debt to fulfill your daily needs.
The ideal amount of emergency fund is a total of 6 to 12 months of your monthly income and depends on your status (married or single). The ideal scale of liquidity ratio is from 6 to 12.
Since this is an emergency fund, keep the money in a liquid, safe, and can be converted into cash quickly. You can choose saving, deposit, mutual fund in the capital market, or gold.
The purpose of these investment products is to keep the liquidity in the short term period, rather than to increase your wealth.
Do you have an emergency fund especially during the isolation because of Coronavirus? Please share your experience in the comment below.
Reducing debt is an important part to improve your financial condition. People have debts because of many reasons.
Not preparing for an emergency fund, lifestyle, impulse buying, buying a new home or vehicle, and education fund, is among the reasons to have debt.
But no matter the reason, you need to reduce debt to gain financial health.
If your debt ratio (debt percentage compared to asset) is less than 50% (ideal standard) then the probability to be broke or bankrupt is lower. You can start making a debt reduction plan to pay down the debts quickly. Some start from paying off the one with lower interest.
Though it doesn’t matter whether starting from a small one, the idea is to get you reducing debt faster according to your financial goals and condition.
You can allocate up to 30% of your income for debt payment. And give 5%-20% to start paying down the unsecured debts first or those with lower interest.
Rules for Financial Health
What do you think about the idea of being healthy financially?
If you have made a check-up and consider necessary parts to obtain financial health, the next thing you’d do is to apply some rules that help the flow of your money in stable condition.
#Add More Income
To maintain stable cash, you need to have income that latter be channeled through saving, investment, emergency fund, or other pockets, according to your financial goals. You can focus on your current job while actively making passive income.
The purpose is so that you can fill up your nest egg. But the effort is not complete yet.
#Keep Your Money
This means that after making money, you should keep it into saving and investment. It also means that you make a spending priority. Here is the list in order:
If you are an employee, you’ll get a tax cut for your income.
After tax-reduction, you can use some of it for charity, donation, or religious obligation (tithe, zakat, etc.). The portion can be 10% – 20%.
#3 Saving and Investment
After giving to charity, allocate the money to saving and investment. For saving, investment, debt, and insurance, you can spend a maximum of 30% of your income each month.
Pay down your insurance premium. The purpose of insurance is to protect you from financial loss or going bankrupt.
Allocate your money to pay off your debt installments such as credit card, home, vehicle, electricity, internet charge, and other installments.
#6 Monthly expenses
You can then pay down your monthly expenses. Set aside at least 40% of income for monthly expenses.
#7 Want and entertainment
You can set aside a maximum of 20% of your income for want and entertainment.
#Accelerate Your Wealth Growth
Investment is the right instrument to grow your money faster. You can expect two goals in investment, capital gain, and cash flow. Capital gain aims at growing your capital.
Investment products to obtain capital gains such as mutual funds, stock, and forex trading, and buy and sell a property.
On the other hand, cash flow aims at obtaining a flow of cash regularly, it can be monthly, every 3 or 6 months, or annually. The investment product of this type is a dividend-paying stock, P2P lending, bond, or renting.
Getting to know your financial health better can change the way you manage your money. It helps you not only to improve your financial condition but also to achieve your financial goals including growing your wealth.
Hopefully, you find this article useful to improve your financial health. Please tag this article to those who also want to have healthy finance.
- Julia Kagan. January 14, 2020. Financial Health. Investopedia.com – https://tinyurl.com/rjvrbsf