When was the last time you went to the doctor for a check-up?
We value our physical health, as we should, by going to the doctor for an evaluation. Your financial health, like your physical health, needs to be assessed every so often.
Whether it’s preventative or to diagnose an issue, a check-up is necessary to have an awareness of where we stand and what adjustments we might need to make in our lives.
Here are five simple steps to evaluate your financial health.
Calculate your debt-to-income ratio
For those who have never performed this exercise, your deb-to-income ratio is calculated by taking the total amount you pay in debt payments per month and dividing it by your monthly gross income. For example, let’s assume your monthly gross income (before taxes!) is $6,000, and you have the following debt payments; Mortgage $1,500, Car Payment $250, Credit Card Payments $750.
In this scenario, your total monthly debt payments are $2,500. Now divide that by your gross income of $6,000 and you have your debt to income ratio of 42% (Here’s the math; $2,500 / $6,000 = 0.42).
Most financial advisors and lenders recommend a debt-to-income ratio of 30% or less. Your debt-to-income ratio is important for two reasons.
First, this calculation gives you a good understanding of whether or not you are living within your means. If your debt-to-income ratio is greater than 40%, as it is in this example, it’s time to start worrying about your financial health.
Second, this ratio is the most important factor in determining your credit score and in your ability to secure new credit. Financial institutions are very reluctant to lend to people with high a debt-to-income ratio.
Evaluate your current housing situation
It should come as no surprise that housing is the largest debt item in most Americans monthly budget (applies for both renters and homeowners). With that in mind, it is incredibly important you are living in a place you can comfortably afford. In the example above, someone earning $6,000 per month (gross) should not be living in a house or apartment that costs $3,000.
Evaluate your needs vs. your wants. You may want a five-bedroom home on a 2-acre plot of land. But if you’re a newlywed with no children, who just started a new job, is this something you actually need? Not only are you paying for a larger house and more land, you’re going to be paying to furnish that (unnecessarily) large home!
Resist the urge to keep up with the Joneses and be happy with living in a home that you can afford.
Pinpoint exactly where your money is going
This is a nice follow up to the previous point. In addition to housing, there are plenty of other goods and services people need to (and want to) spend their money on.
In order to ensure your financial health is in order, you must know where every dollar is being spent. If that sounds dramatic or impractical, well then it’s time to simplify your spending!
It is impossible to create a (realistic) budget without having a good understanding of where your money is going. While no one should expect perfection, the closer you are, the better off you’ll be.
Evaluate your current investment strategy
Even if you aren’t currently investing, please do not skip this section! The fact that you’re not investing could actually be a big hit to your financial health. But before we get to traditional investing, let’s first talk about savings.
I consider saving for a “rainy day” as an investment. While this might seem obvious to some, not everyone is a natural saver. For some (if not most) saving toward an emergency fund takes a tremendous amount of effort.
As far as traditional investing (401K, stocks, bonds, etc) the most important thing you can do is assess your risk tolerance. Depending on your age and financial situation, you ability to take risks (like investing 100% of your money in stocks) changes drastically. If you’re more risk adverse, you may want to diversify your portfolio.
Create financial goals for yourself and your family
Last but not least, it is absolutely imperative that you establish clear financial goals for yourself and your family. Although this was listed as the last action item, it should be the very first thing you do when giving yourself a financial checkup. Without first building a roadmap of where you want to go, it’s impossible to determine which path you should take in building your financial future.