It happens all the time. A friend, out of nowhere, will tell me how much they have in their bank account and then ask for my approval that they are doing well. It’s not only obnoxious, but it also tells me very little about how they are doing financially. While at some point having a ton of money might signal that you’re in stellar financial health, having lots of money is not the end all be all of financial fitness. In fact, financial planners like me measure someone’s financial health on multiple levels, not just how flush your accounts might be. Here are eight important markers I evaluate.
You’ve identified, quantified and prioritized your goals
Nothing says you’re heading in the right direction like actually knowing where you’re going. If this sounds basic, it is. Yet, I can’t tell you how many people haven’t even identified their financial goals. How can you expect to succeed when you don’t know what it is you want for yourself? It’s time to figure it out. Don’t stop there. Go further by quantifying your goals by both time and value. Lastly, know which of your goals are most important by prioritizing them from most to least important. This step alone is more than half the battle of being in good financial health.
You’ve mastered cash flow
With your goals in place, the next thing I look for is one’s mastery of cash flow. This means that you intimately understand how money is coming in and out of your financial life. I want to see someone forecast what the next three months of their life are going to look like from a cash flow perspective. Getting to this level of control takes time and discipline, so don’t expect to be a master overnight. Start by looking back three months at your spending habits. Then, create a budget using your spending categories. Any spreadsheet software will do. Lastly, live your life for at least three months, reconciling your living expenses against your budget. Make adjustments, rinse and repeat until you’re as disciplined as a ninja warrior. Oh, and remember, there are no shortcuts here. Do the (boring) work. It’s that important.
You don’t have credit card debt
Debt will inherently be a part of your life and most of us need to take loans to handle the big purchases such as homes, transportation, and educations. However, credit card debt has no place in our lives. Masters of cash flow do not have credit card debt. The bottom line is that credit card debt is toxic, costly and flat out demonstrates a lack of discipline in your ability to manage cash and live within your income. If you got it, get rid of it. End of story.
You keep your debt under control
Just because you don’t have credit card debt doesn’t mean you are in the clear when it comes to debt. Generally, a good ratio of debt to income is 36 percent and, if you’re looking to obtain a qualified mortgage, it should not exceed 43 percent. Simply divide your monthly debt obligations by your monthly income to obtain your DTI (debt-to-income) ratio. If it’s too high, maybe paying down debt gets moved up on your list of financial priorities. Further, it should go without saying that making payments on time and in full is essential to good financial health.
You have a cash reserve
The emergency fund is an essential of good financial health. Typically, I want to see three-to-six months of your living expenses in cash. That’s right. Good old cash. The more uncertain you feel about your financial life the more months you should have. If you feel invincible, maybe you can be a tad more aggressive holding less. No matter what you decide, having the ability to cover your living expenses for multiple monthly without touching other assets or taking on debt is the stuff a financial planner’s dreams are made of. By the way, we don’t care that your reserve doesn’t earn you any interest. That’s not what it’s for.
You have at least a good credit score
According to FICO, a good credit score is between 670-739. Obviously, the higher the better, but obtaining at least good credit is going to demonstrate that you’re in good financial health. Having good credit isn’t just for bragging rights. It goes a long way when it comes to applying for loans to some of life’s biggest expenses. It can literally save you thousands in interest by affording you better rates than if you had average or poor credit. Building solid credit takes time. Start by keeping it simple and first knowing what’s going on with your credit by obtaining your free annual credit report.
You are saving substantially for financial independence
It’s not always true, but often those who are significantly saving for retirement tend to be in good financial health because being able to focus a substantial portion of your savings on longer-term goals, like retirement, is generally an indication that the shorter-term goals are covered. It’s also an indication that you’ve handled many of the points we already discussed above, from having an emergency fund to mastering your cash flow.
You’ve done basic insurance and estate planning
Good financial health means you are prepared for the worst. This primarily means two things. First, it means you have adequate life insurance in the event you or your significant other prematurely passes away. Second, it means you have put basic estate planning documents in place. These include a last will, power of attorney, and medical directives. No, this isn’t the most positive side of financial preparation, but let me tell you, there is no such thing as being in good financial health if you haven’t protected those things and people that are most important to you. It’s worth every penny to seek out a reputable trust and estate attorney who can prepare these documents tailored to your specific financial situation.
This list doesn’t cover everything you should be looking for, but it’s a great start in understanding where you stand from a financial health perspective. While you should be hitting most of them, I encourage you not to get frustrated if you find yourself lacking in some areas. Instead, use this list as an opportunity to strengthen areas you find yourself weak. Your financial self will thank you.