The concept of financial health involves forces beyond our control. Just as physical health is a combination of behavior, genes and access to good medical care, financial health is a result of personal decisions and abilities, the economy and access to good, unbiased financial services and advice.
Definitions of financial health typically have three factors in common:
- Ability to manage your day-to-day financial life
- Capacity to absorb a financial shock
- Confirmation that you’re on track to meet your financial goals
How do you get there? These eight behaviors can help:
- Spend less than you earn
This is the foundation for financial health. You can’t get out of debt or save for the future if your expenses eat up all of your available income.
- Pay bills on time
Manage your cash flow and meet your regular financial obligations. Missing payments costs you money in late fees, hurts your credit and causes stress.
- Build a decent emergency fund
“Decent” varies according to your circumstances. The Center for Financial Services Innovation, which developed ways financial institutions can measure consumer financial health, would like to see everyone have six months’ worth of living expenses set aside. But as little as $250 can be enough to save a low-income family from a serious financial setback, according to a study by the Urban Institute, a policy research group. What’s more important than the amount is developing a habit of saving regularly. [Shameless plug: If you need a savings account, check out First Internet Bank’s three options.]
- Get (or stay) on track with retirement savings
How much you need will vary by age and circumstance, but do the calculations and set aside money regularly to get you there. If you have other goals, such as buying a home, you should be saving toward those as well. [Another friendly reminder: First Internet Bank can help fund your retirement through our IRA CDs.]
- Keep your debt load at a sustainable level
The Center for Financial Services Innovation recommends that mortgage payments should consume no more than 28% of your pretax income and that all debt payments, including a mortgage, should be less than 36%. Another benchmark is the 50/30/20 budget: Keep housing payments and other must-have expenses — transportation, food, utilities, child care, insurance and minimum loan payments — to 50% or less of your after-tax income. That will leave you 30% for wants and 20% for debt repayment and savings. An even simpler gauge is whether your debt keeps you up at night.
- Avoid credit card or other high-rate debt
Mortgages pay for homes that can increase in value, and student loans provide an education that can help increase your income. That’s why they’re often described as “good” debt, when used in moderation. There’s typically nothing good about credit card debt, which often leaves you paying for items long after you’ve used them up. Credit cards can be helpful if used responsibly. Remember to pay your credit card off every month, and consider a card that provides cash back.
- Be aware of just relying on your credit score
Some people treat credit scores as a proxy for financial health, when they really only measure how well you repay debt. But good credit is a safety net when you need it. It’s also a money-saver even if you’re not planning to borrow; bad credit can increase your insurance premiums, prevent you from getting a house or an apartment and force you to pay larger deposits for utilities.
- Get insured
You want to be protected against financial shocks that could wipe you out, including medical bills, lawsuits, natural disasters or the death of a family member. Health insurance is a must, as is homeowners or renters insurance. If you have a vehicle, you need auto insurance with liability limits that are at least equal to your net worth. If anyone is dependent on your income or services, (including stay-at-home parents) you likely need life and disability insurance.
How would your finances compare?
NerdWallet analyzed data from more than 2,000 Americans surveyed by Harris Poll, scoring them on each facet of financial health. About 10% of them nailed every element, but many more were struggling with debt, retirement and putting aside anything for emergencies.
Well-run personal finances don’t happen overnight. Take the financial health quiz in about 60 seconds and see how you score and what actions you should consider next.
Guest author, NerdWallet
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