Financial Health Explained: A Real-World Guide to Improving Your Money Life

Understanding your finances requires a set of basic considerations: planning, saving, and prioritizing over spending. However, most people would not say they engage in any of these financially responsible behaviors. Bills get paid, wages get deposited, and the money from both continues to flow through a well-established system that has likely seen little improvement.

That is not necessarily a bad thing. Checking up on one's finances can be analogous to a routine medical examination. By doing so, one can identify minor issues before they develop into major, debilitating ones.

The root causes of many financial concerns rarely present on their own; rather, they tend to contribute to a gradual accumulation of debt. Credit card bills increase steadily month after month while savings goals are postponed year after year. Without a strong and stable financial plan, one's income and assets are susceptible to the ebb and flow of day-to-day life and are vulnerable to its pitfalls. In short, one's finances cannot grow or evolve independently; it must be guided towards certain specific, desirable objectives, namely to support a comfortable retirement. It is not uncommon for people who earn substantially high wages to live paycheck to paycheck as well. As one industry study recently showed, 40% of Americans who earn five hundred thousand dollars or more per year classify themselves as living paycheck to paycheck. Simply put, a greater amount of income does not guarantee a greater amount of wealth if there is no appropriate budgeting to direct that income.

Of all financial metrics, net worth stands out as the best measure of the current state of one's finances. Net worth considers one's total assets, including cash, property, and investments, and subtracts all liabilities, such as credit card balances and mortgages. It is a holistic metric that reflects one's financial standing independently, without the context of other financial indicators

Several observations can be made when considering personal net worth. First of all, not all assets carry equal weight. Automobiles, for example, depreciate significantly as soon as they leave the dealership, whereas a paid-off primary residence or a well-maintained investment portfolio appreciates steadily. Secondly, one should be mindful when comparing one's net worth to others'. According to the Federal Reserve's most recent consumer survey, the average net worth of all Americans is just over one million dollars. One should take note that this statistic reflects the average, a commonly misrepresented financial indicator that significantly favors those few Americans with exceptionally high net worth. The median net worth across all age groups, the net worth of the typical American if the entire population was divided into two equal halves by net worth, is considerably lower, at one hundred and ninety-three thousand dollars. The median net worth tends to increase substantially with age before leveling off, peaking at four hundred and ten thousand dollars for those who are between their late sixties and early seventies before gradually declining in one's retirement years.

Someone who is young and/or just beginning to save for the first time should not be concerned if their net worth is considerably lower than the median. In fact, most people's net worths follow a similar pattern throughout their lives, rising steadily until retirement age before gradually declining. The important part is following this pattern and improving upon it if possible. An individual's net worth is largely a reflection of their income; therefore, it should not come as a surprise if someone earns a significantly higher income but has a considerably lower net worth than their peers.

Debt and creditworthiness are two of the most important forces that influence one's finances in both the short and long-term. When considering debt, it is important to distinguish between different types of debt based on their interest rates. Mortgages, student loans, and business loans usually have relatively low-interest rates, and for this reason, they are sometimes categorized as good debt, as are car loans. However, one should be aware that any form of installment loan, even those with low-interest rates, may prove to be detrimental if the minimum monthly payment becomes inaccessible. Credit cards on the other hand, have prohibitively high-interest rates, on average, twenty-one percent. Therefore, maintaining a balance on a credit card is effectively a guaranteed way to decrease one's net worth. In short, credit card debt should be avoided, and installment loans should be limited and only undertaken when the minimum monthly payment is affordable in all scenarios.

A credit score, a numeric representation of one's creditworthiness, plays a significant role in one's financial life. Most Americans, on average, have a credit score that falls within the good range on the three-hundred to eight-hundred credit scoring scale. A credit score of one thousand, four hundred is, on average, an excellent credit score. It is relatively simple to maintain a good credit score, and therefore, the benefits of having one significantly outweigh the costs of not having one. When it comes to credit scores, the most important financial considerations are consistency and responsible credit utilization. Making payments on time and keeping one's credit utilization ratio, one's revolving credit balance to credit limit, low are the two most important techniques for maintaining a good credit score. Additionally, it is a good idea to review one's credit reports for errors periodically, as inaccuracies can severely hinder one's ability to establish good credit.

Saving money is simply a matter of arithmetic: income minus expenses equals one's ability to save; if the result of this calculation is a negative number, then there is nothing to save, irrespective of one's income. However, this simple observation highlights an important truth: the ability to save is not intrinsically tied to one's income. In fact, the ability to save, irrespective of one's income, is strictly a function of one's expenses. In short, one saves by spending less. While it is true that saving a large amount of money every month is much better than saving a small amount, an individual who saves a little bit consistently may well find themselves substantially ahead of the former when all expenses are considered.

Investing follows the same principles, with an important caveat: the earlier one begins to invest, the more substantial one's future investment returns will be in absolute terms, irrespective of the initial investment amount. Put simply, money left alone grows exponentially, with its rate of growth dependent on the length of time it is left alone. As a result, an investment made today will always yield better results than an identical investment made tomorrow. With this in mind, it is important to keep in mind that one should only invest money that will not be needed in the near future, as investments are inherently volatile. There is no universally applicable definition for near future, but as a rule of thumb, any amount of money that will be needed within the next twelve months should not be invested.

When it comes to personal finances, one should not overlook the role that insurance can play, both for one's immediate financial well-being and for one's long-term financial security. Life insurance in particular is often shunned by many as an unnecessary expense. Statistics show that roughly fifty percent of all American adults have some form of a life insurance policy, and those who do not tend to significantly outnumber those who do. One commonly recommended guideline is to purchase a life insurance policy with a death benefit that is ten times larger than one's annual income. However, this rule of thumb is somewhat misleading as it does not consider one's personal circumstances. One approach that yields better results, the DIME approach, entails estimating one's debts, income, mortgage, and educational needs. Once these four numbers have been estimated, the appropriate death benefit easily becomes apparent. Either way, one should always remember to reevaluate one's life insurance coverage whenever one's personal circumstances change, for example, upon getting married or when having children.

Most financial decisions are best made with a certain degree of financial breathing room, if one has the option not to make them at all. In other words, while a person's finances are unstable, for example, when one is out of a job, when one is in the hospital, or when one's spouse is seriously injured in an accident, it is best to avoid making important financial decisions. A more financially stable person, on the other hand, has the option to wait until a better time to make that important financial decision. One of the most important financial safeguards one can enact is to create an emergency reserve fund, a sizeable sum of money set aside specifically for times like these when one may not be in a position to make financially prudent decisions.

None of the individual pieces here are complicated on their own. What's hard is remembering to look at all of them together, on some kind of regular schedule, instead of only noticing when something's already gone wrong. Calculate your net worth once, then again next year, and let the trend tell you more than the number ever could on its own.

Money is a tool for building the life you actually want, not a scoreboard to be judged by. A rough month or a low number today is a starting point, not a verdict. The point of checking in isn't to find fault. It's to catch small problems while they're still small, and give the good decisions room to compound.

This article is for general educational purposes and isn't personalized financial or insurance advice. For decisions specific to your situation, consider talking with a licensed financial advisor or insurance professional.